Why Do We Have A Death Tax?

Not all taxation is theft. But one tax that comes about as close as possible to being theft is the estate tax. After all, dead people aren’t getting any more services from government. I suppose there are a few people who are buried in pauper’s graves at county expense. But those are not the ones whose estates are being confiscated.

I have never understood the logic behind seizing a part of the estates of the recently departed. If there is a valid argument for doing so, why doesn’t it apply with equal force to the estates of the living?

The House of Representatives voted by a large margin the other today to abolish the estate tax. In doing so they took a very popular step.

Yet although the estate tax is one of the most hated taxes by the general public, it has long been a favorite of government. Kelly Phillips Erb reminds us that the first federal estate tax was imposed in 1797 to help fund a war against France. It was resurrected again in the Civil War, then in the Spanish-American War and it became a more or less a permanent fixture with the advent of World War I. War and estate taxation seem to go hand in hand.

By the way, it’s not just the federal government. For an interactive map showing states that impose estate and inheritance taxes, see Where Not To Die In 2015.

I suspect the reason governments like the tax is that estates don’t have very powerful protectors and defenders. If the government tried to seize estates from the living, the owners would certainly resist. But after death, ownership tends to be dispersed and in many cases unresolved. So estates are a relatively easy target for the tax collectors.

But is there a valid public policy argument for taxing estates?

Who actually pays the estate tax?

President Obama says the estate tax is tax on the rich and he wants to increase the take. If he were in Economics 101, his assessment of the incidence of the tax would merit a failing grade. The burden of the estate tax doesn’t fall on dead people. It falls on the heirs — some of whom may be rich and some of whom may not be. If the goal is to tax the rich, then we should be taxing heirs, based on their total income, not the deceased.

Aren’t the children of rich people also rich?

Although it is somewhat dated, one of the best treatments of the estate tax is a study Bruce Bartlett did for the National Center for Policy Analysis. One of the findings: very little of the wealth of wealthy people comes from inheritance. There are exceptions of course. The Walton children are examples. But for the most part, inheritance has a tiny impact on the distribution of income in the United States.

Harvard economist Greg Mankiw has this to say about intergenerational wealth transfers:

The correlation between the lifetime earnings of successive generations is around 0.4 or 0.5. Even adding in inheritances, the figure increases to only about 0.7. This is nowhere near a perfect correlation. And the correlation is far smaller when we look at the link between grandparents and grandchildren, and probably smaller still if we consider nephews, nieces, and other possible heirs.

How easy is it to avoid the tax?

There are a lot of loopholes and the larger the estate, the more likely that they have been exploited. As a result, the very wealthy get taxed at a lower rate than the so-so wealthy. Bartlett writes:

So effective are [the] methods of avoiding estate taxes that it has been argued that the estate tax essentially is a voluntary tax. In the words of economist George Cooper: ‘The fact that any substantial amount of tax is now being collected can be attributed only to taxpayer indifference to avoidance opportunities or a lack of aggressiveness on the part of estate planners in exploiting the loopholes that exist.’ Economists Henry Aaron and Alicia Munnell put it even more bluntly. In their view, estate taxes aren’t even taxes at all, but ‘penalties imposed on those who neglect to plan ahead or who retain unskilled estate planners.’

By the way, it was the unfairness of tax avoidance opportunities that persuaded Sweden (often referred to as a “socialist” country) to abolish the estate tax about a decade ago. Austria, Canada, Hong Kong, India, Israel, New Zealand, Norway, Russia and Singapore are some other countries that have abolished their estate or inheritance taxes.

Who would benefit from a repeal of the estate tax?

Mankiw argues that we would all benefit. Here’s why:

The estate tax is a tax on capital. As such, one would naturally expect it to discourage capital accumulation. Now, put this together with the fact that a smaller capital stock reduces productivity and labor income throughout the economy and the implication is clear: the repeal of the estate tax would stimulate growth and raise incomes for everyone, even those who never receive a bequest.

Wouldn’t the government lose revenue if the estate tax were abolished?

Currently the federal government gets less than 2 percent of its income from the estate tax. Even though the sum seems paltry, wouldn’t this revenue be lost if the estate tax were abolished? Mankiw writes:

The estate tax encourages people to take avoidance actions, such as making gifts to their children. Since their children are almost always in lower tax brackets, these gifts reduce income tax collections. Repealing the estate tax would remove the incentive for such gifts and would thereby boost income tax revenues.

And, as noted, revenue that the government did not collect from the death tax would largely remain in the productive private capital market, boost incomes and (therefore) produce additional taxes on those incomes. In fact, Mankiw speculates that the government might not lose any revenue at all from the abolition of the tax.

Originally posted on Forbes on April 27, 2015.