Here is an Economist article, with my comments in italics.
The remarkable thing about the article is its lack of consideration of basic economic theory and a failure to focus on what produces a high standard of living for most of the people over time. Instead it falls into the trap of basing policy on “fairness”, “equality” and other subjective and economically irrelevant issues. The problem with the latter is that it leads to policies that feel good but make most people worse off over time. “feel good” is a poor substitute for useful analysis.
Another remarkable aspect is the incompatibility of the authors’ expressed opinions and preferences with freedom.
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No Tax is popular. But one attracts particular venom. Inheritance tax is routinely seen as the least fair by Britons and Americans. This hostility spans income brackets. Indeed, surveys suggest that opposition to inheritance and estate taxes (one levied on heirs and the other on legacies) is even stronger among the poor than the rich.
Politicians know a vote-winner when they see one. The estate of a dead adult American is 95% less likely to face tax now than in the 1960s. And Republicans want to go all the way: the House of Representatives has passed a tax-reform plan that would completely abolish “death taxes” by 2025. For a time before the second world war, Britons were more likely to pay death duties than income tax; today less than 5% of estates catch the taxman’s eye. It is not just Anglo-Saxons. Revenue from these taxes in OECD countries, as a share of total government revenue, has fallen sharply since the 1960s (see article). Many other countries have gone down the same path. In 2004 even the egalitarian Swedes decided that their inheritance tax should be abolished.
There is good reason for this. Inheritance taxes penalize those who save and invest vs. those who consume. It is the former that produce economic growth that benefits all.
Yet this trend towards trifling or zero estate taxes ought to give pause. Such levies pit two vital liberal principles against each other. One is that governments should leave people to dispose of their wealth as they see fit. The other is that a permanent, hereditary elite makes a society unhealthy and unfair. How to choose between them?
The two “vital liberal principles” should be characterized as freedom versus theft.
Government should leave people to dispose of their wealth as they see fit – just as it leaves people to spend their wealth as they see fit while they are alive. Spending wealth now is no different from giving it to someone else to spend later. Inheritance taxes encouraging consumption now versus investment now, which reduces economic growth, creates fewer jobs, and reduces the standard of living for the average citizen.
A permanent hereditary elite does not exist. It is a hypothetical that ignores the tendency of wealth to grow more slowly than family members and ignores the diverse views of those family members. Where are the rich descendants of railroad barons, etc.
An “unhealthy society” is a meaningless substitute for analysis, as is “hereditary elite”. “Fair” is always in the eye of the beholder and has no analytical value.
When the heirs loom
Some people argue for a punitive inheritance tax. They start with the negative argument that dead people no longer enjoy the general freedom to disburse their wealth as they wish—as the dead have no rights. How could they, when they are not affected one way or the other by what happens in the world?
That does not ring true. The logic would be to abrogate even the most modest of wills. But inheritances are deeply personal and the biggest single gift that many give to causes they believe in and loved ones they may have cherished. Many (living) people would feel wronged if they could not provide for their children. If anything, as the expression of their last wishes, bequests carry more weight than their passing fancies do.
The key insight is that people have the choice to spend after tax dollars or save them, invest them, and leave the resulting wealth to others. It is no different than giving the after-tax dollars to others to begin with – except that society gains to the extent they are invested rather than spent. Taxing inheritances is no more fair or sensible than taxing wealth prior to death or taxing consumption paid with after tax dollars. Note the authors’ complete lack of analysis concerning what benefits the economy and the average citizen.
The positive argument for steep inheritance taxes is that they promote fairness and equality.
This is “feel good” nonsense.
The fairness argument is subjective and reflects emotion rather than analysis. The equality argument ignores the adverse consequences. If equality is economically optimal, then it all wealth should be confiscated and divided equally among everyone. That would destroy the incentives necessary for a high standard of living and ruin the economy. So, equality cannot be optimal. Nor is there any sensible argument for it being “fair”. A reasonable definition of “Fair” is when you are allowed to be rewarded for doing things people are willing to reward you for – and not having your reward taken away later by an armed thug (the government).
Heirs have rarely done anything to deserve the money that comes their way.
More “feel good” nonsense.
Note the focus on “deserve” instead of what is relevant to what tax policies benefit the average citizen most. The homeless person on the street also has done nothing to deserve the money you give him. “Deserve” has no place in an economic argument, or a serious intellectual discussion. “Deserve” has to do with bitterness, jealousy, etc., not economics and how to have as high a standard of living as possible for as many people as possible.
Liberals, from John Stuart Mill to Theodore Roosevelt, thought that needed correcting. Roosevelt, who warned that letting huge fortunes pass across generations was “of great and genuine detriment to the community at large”, would doubtless be aghast at the situation today.
That JSM to TR were wrong argues against being impressed by their possibly being “aghast at the situation today”.
Annual flows of inheritance in France have tripled as a proportion of GDP since the 1950s. Half of Europe’s billionaires have inherited their wealth, and their number seems to be rising.
One way of putting this in perspective, assuming it is true, is to be happy that the original wealth creators did so much that ordinary people liked that they were willing to pa billions in return. A good portion of this may not have been done if there had been a high inheritance tax – what would have been the incentive to invest as opposed to consume? In any case, this “fact” is irrelevant.
However, in 2017, it is not clear exactly how decisive a role inheritance plays in the entrenchment of the hereditary elite.
The “hereditary elite” is a nice phrase, but irrelevant. They may consider themselves “elite”, but it is rare for others to do so. Moreover, they have only one vote per person, just like the rest of us. “entrenchment” also is a nice term. Both are used here to create a pejorative for rhetorical purposes – not logical ones.
Data from Britain suggest that people tend not to lose their parents before they reach the age of 50. In rich countries the advantages that wealthy parents pass to their offspring begin with the sorting mechanism of marriage, in which elites increasingly pair up with elites (see article). They continue with the benefits of education, social capital and lavish gifts, not in the deeds to the ancestral pile.
So what?
Even if the link between inheritance-tax rates and inequality were clear, wealth can pay for a good tax lawyer. In the century since Roosevelt, Sweden and other high-taxers discovered that if governments impose a steep enough duty, the rich will find ways to avoid it. The trusts they create as a result can last even longer than the three generations it takes for family fortunes to go from clogs to clogs.
This fails to consider the trust value per beneficiary, which declines over time.
Armed with such arguments, some leap to the other extreme, proposing, as the American tax reform does, that there should be no inheritance tax at all. Not only is it right to let people hand their private property to their children, they say, but also bequests are often the fruits of labour that has already been taxed. And a large inheritance-tax bill is destructive, because it can cause the dismemberment of family firms and farms, and force the sale of ancestral homes.
All very true and more than sufficient to eliminate inheritance taxes, even disregarding the adverse impact of inheritance taxes on standard of living generally through destruction of incentives that hurt everyone.
Yet every tax is an intrusion by the state. If avoiding double taxation were a requirement of good policy, then governments would need to abolish sales taxes, which are paid out of taxed income.
Strawman. A better choice would be to eliminate income taxes in favor of a value added tax. That would level the playing field, with the added benefit that everyone would have an incentive to reduce government spending.
The risks that heirs will be forced to sell homes and firms can be mitigated by allowing them to pay the duties gradually, from cashflow rather than by fire-sales.
The issue is confiscation, not how to pay for it. In effect, you are being forced to “donate” a large interest in your home or business to the government just before you die.
In fact, people who are against tax in general ought to be less hostile to inheritance taxes than other sorts. However disliked they are, they are some of the least distorting. Unlike income taxes, they do not destroy the incentive to work—whereas research suggests that a single person who inherits an amount above $150,000 is four times more likely to leave the labour force than one who inherits less than $25,000.
Percentages, please. This is unlikely to be a significant effect – you can’t live on the income from $150,000. Moreover, the statistics don’t make sense in terms of productivity. Also, that there are other taxes that may reduce incentives to produce more than this one is not an argument to keep this one – rather, change the tax structure throughout to minimize reduced incentives to produce?
Unlike capital-gains taxes, heavier estate taxes do not seem to dissuade saving or investment.
This assertion conflicts with basic economics. Raising the price of something (investing so as to leave heirs wealth) reduces its demand (increases current consumption). Investing provides a higher economic growth rate, hence helps everyone.
Unlike sales taxes, they are progressive.
Progressive is not synonymous with good, fair, or a growing economy. It is more often a code word for justifying stealing other people’s money to spend on your pet projects.
To the extent that a higher inheritance tax can fund cuts to all other taxes, the system can be more efficient.
An assertion with no basis in fact. There is no analysis of the comparative advantages of alternate tax structures.
Transfer market
The right approach is to strike a balance between the two extremes. The precise rate will vary from country to country. But three design principles stand out. First, target the wealthy; that means taxing inheritors rather than estates and setting a meaningful exemption threshold. Second, keep it simple. Close loopholes for those who are caught in the net by setting a flat rate and by giving people a lifetime allowance for bequests; set the rate high enough to raise significant sums, but not so high that it attracts massive avoidance. Third, with the fiscal headroom generated by higher inheritance tax, reduce other taxes, lightening the load for most people.
All this follows from the Economist’s failed analysis. It is no more than nonsensical “feel good” personal preference – and is nonsense.
A sensible discussion is hard when inheritance taxes prompt such a visceral reaction. But their erosion has attracted too little debate. A fair and efficient tax system would seek to include inheritance taxes, not eliminate them.
The article’s flawed “feel good” reasoning does not support the “fair and efficient” characterization.
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