“Death Taxes” are for the Living

“We can have concentrated wealth in the hands of a few or democracy–but we cannot have both.”
–Supreme Court Justice Louis Brandels

Since the 2001 tax cuts, there has been a slow phasing-out of the estate tax until the tax was fully repealed at the beginning of this year. Absent any further legislation, the Bush tax cuts will expire at the end of 2010, including the estate tax. (We’re going to see a lot of dead grandparents this year!) There will inevitably be a political storm over extending the Bush tax cuts. Although Obama himself made tax cuts part of the economic stimulus in early 2009, he is widely expected to allow the Bush tax cuts to expire at the end of the year. This should be good news for deficit hawks. If we are going to get back to a balanced budget, the additional tax revenues will be necessary (although not sufficient).

The estate tax (AKA, the inheritance tax) is one of the oldest forms of taxation. It has been in place since 1916 in the U.S., until it was repealed earlier this year. According to the Brookings Institute, the estate tax only affects the wealthiest 2% of the U.S. population (i.e., the majority of those paying the tax had fortunes in excess of $5 million). Of the $550 billion that is transferred from one generation to another, the estate tax brings in $20 billion each year to the U.S. treasury (other sources say that the federal government lost $56 billion in 2010 because of the tax repeal). Estate taxes have rarely contributed more than 2% to federal budget. But this tax is not just about finding another revenue stream for the government. It is a wealth control program that lies at the very heart of American values.

In many ways, America was born out of the idea of rejecting aristocratic power and privileged (even if those forces have always been present). Since our founding, we have sought to put power in check (even–perhaps especially–our government), and to allow equal opportunity for all. We also value “the self-made man,” who earned his/her way to success through hard work, not through nepotism or privilege (in other words, not Paris Hilton!). In short, we wanted a society based more on meritocracy than aristocracy, and inheritances leads to an unequal material starting positions for members of society. Without a control mechanism, family dynasties of the ultra-rich are a threat to these values.

Political commentators, such as Robert Frank of the Wall Street Journal, want to believe that the rich earned their own way. But when $550 billion is passed on each year, with only $20 billion collected, there are plenty of people getting a free ride. When the ultra-rich hand off their fortunes to their descendants, we have a situation where a dynastic ruling class emerges, made up of people who did not earn most of what they have (or at least didn’t get there under the same rules that the rest of us do), and these people are now on the boards of our businesses, buying our elections, and funding lobbyists.

Currently, the richest 10% of households in the U.S. owns almost 70% of all private wealth, while the bottom 50% of households hold a meager 2.8%. This is hardly an even playing field for the market to give opportunity for the best ideas and talents to emerge. Renowned sociologist, Max Weber, said the revenues from the inheritance tax should be evenly redistributed among young members of society, so as to create equal starting conditions for the “market struggle.” Part of the objective of the tax is to even the playing field. In American political discourse, if we can’t agree on equal outcomes, surely we can agree on equal opportunity.

We are not talking about people who have worked hard and saved throughout their lives and want to pass it on to their family. This group does not generally pay estate taxes. We are talking about descendants of the ultra-rich investing a portion of their massive, unearned inheritance (the part that did not go to charity) toward the betterment of society and back into the system. After all, it is the system that allowed their generous donor to get ahead in the first place–without a freedom infrastructure of transportation, a legal system, security, monetary system, etc., the accumulation of wealth would be impossible. Again, the estate tax only affects the wealthiest 2% of tax payers. On a $10 million estate, the effective rate, after exemptions, averages 19%–which is hardly confiscatory.

There are many positive outcomes from the estate tax. The tax encourages charitable giving, since these contributions are deductible from the estate tax. It controls the size of private wealth, which, if unchecked, could concentrate political and fiscal power in the hands of a few, and jeopardize democracy. The tax also removes the expectation that wealthy heirs can coast off the wealth of others. Removing the expectation of a large inheritance encourages would-be recipients to earn their own way. This argument should be especially appealing to conservatives who emphasize personal responsibility and productivity while condemning “handouts” drawn from “other people’s money.” In fact, this idea is why a number of capitalist icons have favored the estate tax. Here are a few:

  • Adam Smith, 1776: “[Inheritance taxes] seldom maintains but unproductive laborers; at the expense of the capital of the people.”
  • Andrew Carnegie, 1889: “Of all the forms of taxation this seems the wisest…I would as soon leave my son  a curse as the almighty dollar.” Carnegie felt that wealth not transferred to foundations during the owner’s lifetime should be subject to high inheritance taxes, for “the man who dies thus rich dies disgraced.”
  • Warren Buffet, at a 2007 Senate Finance Committee hearing: “Dynastic Wealth, the enemy of meritocracy, is on the rise. Equality of opportunity has been on decline. A progressive and meaningful estate tax is needed to curb the movement of a democracy toward a plutocracy.” Buffet argued against repeal in the New York Time, saying it would “be a terrible mistake,” comparable to “choosing the 2020 olympics team by picking the eldest sons of the gold-medal winners in the 2000 olympics.” (see the video below)

In 2001, more than 2,500 multi-millionaires and billionaires signed a public petition, sponsored by Responsible Wealth, in favor of retaining the estate tax. (See also: Why Capitalists Should like the Estate Tax)

Thomas Adams, a leading tax economists, argued that “if we must tax, it is better to tax him who merely receives than him who earns.”

Detractors of the tax call it the “death tax.” First off, dead people don’t (actually, can’t) pay taxes. Second, only a small fraction of U.S. deaths result in a positive estate tax payment. Detractors emphasize the property of the donor, rather than the receiver of the inheritance income. They claim it is a “double taxation” on the hard-earned money of the deceased individual. This is also incorrect because, although the deceased person may have paid income taxes initially, it is the receiver who pays the estate tax, since they are receiving income (Of course, if the donor wants to pre-pay the tax liabilities that the receiver will have to pay, they can effectively pre-paid in the form of life insurance tied to expected tax liability). The recipient pays (once), not the donor (twice). Claiming “double taxation” does not make sense, since our entire tax system works this way (i.e., taxing each level where income is received). However, there are circumstances where the same income on large fortunes could be taxed more than once (e.g., [1] income tax, [2] dividends and capital gains, [3] estate tax).

Critics also say that the tax makes it difficult to pass on businesses and farms to the next generation. However, the American Farm Bureau Federation could not find a single instance of a family farm that was forced out of business because of the tax (source). The vast majority of family businesses are not subject to the estate tax (source); in fact, according to the IRS, only 11% of the estate tax collections in 2000 were from farms and small businesses. Because of deductions, exemptions, and valuation procedures, many small businesses are passed on to their heirs tax-free. “The vast majority of small business wealth subject to the estate tax has taken the form of unrealized capital gains; this income has never been taxed under the income tax and would never be taxes at all if exempted from the estate tax” (source). So it can be argued that the estate tax makes up for the forgiveness of capital gains taxes on appreciated assets held until death (i.e., income that was never taxed). Moreover, even when small businesses and farms must pay the tax, they are able to pay (the IRS) in installments over a 14-year period.

Conservative commentators sometimes argue that the tax should be repealed because the ultra-rich (upper-upper class) will find ways to avoid the tax while the upper class or even the upper-middle class end up paying a higher percentage. (When did conservatives start believing in progressive taxation?) Bruce Bartlett argued in The Public Interest (Fall 2000): “So effective are these methods of avoiding the estate taxes that it has been argued that the estate tax is essentially voluntary.” This is a surprising admission from the right. The ultra-rich may be thieves and law-breakers (as this quote suggests), but conservative facts are not accurate in this area. Actually, evasion of the tax is estimated to be only about 13% (source). Perhaps the other 87% are law abiding in this area after all (“evasion” does not include those who spend a good chunk of change on “estate planning” to semi-legally bring down their tax payment).

The estate tax is not the only solution, but it is an important part of a progressive tax system that creates opportunity for all U.S. citizens. In 2006, Nobel Prize recipient and New York Times columnist, Paul Krugman, pointed out that:

  • A few people are getting much, much bigger slices [of the economic pie]. Although wages have stagnated since Bush took office, corporate profits have doubled…The gap between the nation’s CEOs and average workers is now ten times greater than it was a generation ago…from less than thirty times the average wage to almost 300 times the typical worker’s pay. For the first time in our history, so much growth is being siphoned off to a small, wealthy minority that most Americans are failing to gain ground even during a time of economic growth…
  • America actually has less social mobility than other advanced countries: These days…It’s easier for a poor child to make it into the upper-middle class in just about every other advanced country — including famously class-conscious Britain — than it is in the United States.
  • Not only can few Americans hope to join the ranks of the rich, no matter how well educated or hardworking they may be — their opportunities to do so are actually shrinking. As best we can tell, pretax incomes are now as unequally distributed as they were in the 1920s — wiping out virtually all of the gains made by the middle class during the Great Compression [1940s-1960s].
  • These days, to find societies as unequal as the United States you have to look beyond the advanced world, to Latin America. And if that comparison doesn’t frighten you, it should…the statistical evidence shows, unequal societies tend to be corrupt societies. When there are huge disparities in wealth, the rich have both the motive and the means to corrupt the system on their behalf. (Source: The Great Wealth Transfer, By Paul Krugman, Rollingstone, 12/22/06)

If the estate tax were permanently repealed, working people would have to pay for the tax cut through either cuts in services or an increased tax burden. With the Democrats in control, the tax will expire at the end of the year. Can you say, “Hope…and…Change”? Of course, an election can change the game very quickly, as the Republicans found in 2006. Let’s hope that ordinary Americans realize what is at stake in the coming elections.

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