Conservatives, who seem intent on tearing their movement apart, have come together on two seemingly unrelated issues: affirmative action and inheritance taxes. Both, it seems, are bad. Affirmative action is bad because it gives certain groups (blacks, Hispanics, women) an unfair advantage in life’s race for success. And inheritance taxes are bad because . . . well, because they deny certain groups (inheritors of the product of someone else’s success) what Trent Lott calls “a little jump start . . . so that they can be successful.”
It seems that if your parents were successful, you are entitled to special treatment by government — a reduced tax (many conservatives prefer zero tax) on income received from your ancestral benefactors. If the Republicans have their way and the new budget accord passes the Congress, if you work hard and have taxable income of $ 1.2 million, you will pay almost $ 500,000 in income taxes (married couple, joint return). But if you receive an inheritance of $ 1.2 million, you pay no taxes. (Technically, it’s not you, but the estate that pays, which amounts to the same thing.)
The argument I am about to pose in favor of a draconian inheritance tax is based in part on economics and in part on broader considerations of equity and social policy. I am a firm believer in tax cuts and consider myself very much a libertarian. Given these facts, my position might seem a little quixotic, not to say quirky. So, in the hope of retaining what little affection my fellow conservative friends may have for me, let me classify the discussion I am about to undertake as a “thought experiment” — an attempt to face the implications of a conservative worldview as fearlessly as possible.
Like any thought experiment worthy of the name, it is an effort designed to lead my friends to a conclusion far different from the one they now hold. But the opposite is also true — it might result in a rebuttal sufficiently persuasive to convince me of the errors of my ways. In that event, I will willingly accept the notion that some persuasive purpose as yet unrevealed to me is served by lowering the inheritance tax rather than by raising it to a level that is close to confiscatory.
My concern is to preserve and strengthen the American culture of entrepreneurship. So let me make it clear that I do not wish to argue in favor of the current system of estate taxes, because the current system does almost nothing to further the entrepreneurial culture (unless you are a lawyer looking to hang out an estate-tax shingle). And so, for the purposes of this argument, I will bend to the most public and tear-stained conservative objection to the estate tax and say that estates in the form of family farms and small businesses should be taxed at a rate of 0 percent. Economically, it doesn’t make much difference. Taxes on such assets constitute less than 7 percent of all estate taxes collected in this country. Only one in 25 farmers leaves a taxable estate; the median estate tax paid by farmers is only $ 5,000; and right now inheritors of small businesses may take over 14 years to pay their estate taxes, with interest charged at a bit below market rates.
Nevertheless, we should eliminate any possibility that our new system of inheritance taxes might result in forced liquidations, and thus go with the zero rate. I say this only to clear this bit of underbrush from our path. But in truth, if a business or farm is taxed at fair market value, the inheritor should still be able to borrow against that asset to raise the necessary taxes and retain a substantial equity position in the business he or she has come into by chance of birth.
But for purposes of this thought experiment (and despite the possibility that it will result in the establishment of bogus businesses as vehicles for tax avoidance) let’s pander a bit to conservatives’ desire to preserve the balance sheets of inherited farms and businesses in their pristine condition, and exempt them from our inheritance tax.
Now, on to the confiscation.
To begin with, remember that the only wealth transfer that an inheritance tax can interfere with is the part that involves financial assets. An inheritance tax cannot deny children the most important inheritances they receive from their parents. For one thing, it is no longer in substantial dispute that intelligence is substantially heritable; we simply do not know what portion. Nor can tax policy deny children what economist Gary Becker, in his Treatise on the Family, calls “endowments of family reputation and connection; [and] knowledge, skills, and goals provided by their family environment.” Nor can children be denied the advantages that in here in what Glenn Loury, in a recent issue of the Public Interest, calls “networks of social affliation” — education, the “parenting skills” of one’s mother and father, acculturation, nutrition, and socialization in one’s formative years.
A study by Thomas Dunn and Douglas Holtz-Eakin for the National Bureau of Economic Research, for example, suggests that parents’ human capital, far more than any financial assets with which they may endow their offspring, affects “the propensity to become self-employed.” In other words, the entrepreneurial spirit and the tools needed for success are the best things that parents can bequeath children — and it would be difficult to demonstrate that the fact children know they may be showered with money they did not earn later in life enhances that spirit.
The principal objections to our inheritance tax are that it would give the government more money to waste, and that it could easily be avoided, either with the help of specialists in that art or simply by working less so as to accumulate less. Neither objection withstands scrutiny.
The revenues from such a tax could be used to reduce the marginal rates of income tax, producing all the wondrous benefits conservative supply-siders confidently predict for such a reduction. By such a move we would have reduced the tax on work by increasing the tax on the less productive activity of being around when someone dies. The government gets no more revenue, and the economy grows faster. And — libertarians take note — our new inheritance tax would not represent an increase in the government’s power over the citizenry. The compulsion to pay income taxes would be reduced, dollar for dollar, to the extent that the compulsion to pay inheritance taxes was increased. Put slightly differently, the amount of national income subject to government seizure is not increased.
None of this is to deny that the higher the inheritance tax rate, the greater the incentive to devise schemes to avoid the tax. Or that there will be many a slip between taxpayer cup and tax-collector lip. But that is true of most taxes: We all know how sales taxes on big-ticket items are avoided by shipping purchases to out-of-state addresses, and how capital-gains taxes are avoided by a variety of techniques such as selling short against the box. The possibility of some tax avoidance, in short, is not a compelling reason to fail to levy a tax that is otherwise justifiable on economic and policy grounds.
No doubt, every effort will be made by those planning their estates to evade a 100 percent inheritance tax. And, given their ability to enlist the finest minds the nation is wasting in the accounting and legal professions — what the Heritage Foundation calls “a substantial cottage industry devoted to estate tax avoidance” — there will be evasion. But such evasion is unlikely to have major anti-social consequences.
Gifts during one’s lifetime — $ 10,000 a year can be transferred tax-free – – already provide a bit of an escape. And more can be done in one’s children’s interests with the money that would otherwise be left behind: Instead of leaving financial or other assets to be taxed, parents might spend large sums enriching the educations of their offspring while the parents are living. To the extent that the inability to leave financial assets to the next generation encourages parents to spend still more on their children’s education, parents’ incentives to work to meet the costs of such education are increased, and the nation’s stock of intellectual capital is enriched.
The other possibility is that oldsters might simply retire sooner in order to accumulate less money. If they elect this option of early leisure, the supply of labor will be reduced, a bad thing from society’s point of view. But the now not-so-rich heirs will have to work harder, which would increase the available supply of labor (and younger labor at that). No precise computation of the net effect on labor supply and costs is possible, but there is no reason to believe that society will be the loser by trading some years of oldies’ labor for some years of more intense labor by younger folk.
Finally, those about to depart this mortal coil, anticipating that terminal event, might donate their money to charity. No social loss there. Or they might simply spend their money on pleasure binges, a final thumb-in-the-eye to the waiting tax collector. If a 100 percent inheritance tax did indeed induce such consumption, it would replace the eventual consumption of the heirs to whom those who earned the money would in other circumstances have directed it. It is difficult to see what large-scale social loss is involved, unless we want to argue that older people derive less satisfaction per dollar spent than do younger people. This seems highly unlikely, given seniors’ superior experience in separating the truly pleasurable from the merely fashionable.
It is important to note at this point that no inheritance tax should apply to transfers of wealth between spouses. Inheritances of spouses are not now taxed, and should not be, since the inheritance consists of accumulated income earned by both, whatever the distribution of work between office and home happened to be.
So there you have it: A policy towards inheritance taxes that is consistent with opposition to affirmative action and other government preference programs, that encourages young people to work, that induces seniors to invest in the intellectual capital of their offspring and to increase their charitable donations, and that promises to lower income taxes and thereby stimulate growth.
These of course are in the main economic arguments against favored tax treatment of inherited wealth. Such arguments can never be dispositive; public policy must be based on more than economics. But it also must be informed by economics, and those who choose to override economic arguments have the burden of rebutting them by showing that the economic costs of their proposals are exceeded by some higher values. And they must, it seems to me, also be quite explicit in describing the social values that should be given precedence over the long-held and very American ideal of equality of opportunity, a level playing field, or whatever term might best describe a fair field with no favors.
Nothing here suggests that parents be denied the opportunity of passing on to their children any social advantages inherent in their birth or upbringing. Nothing here suggests that parents be in any way limited in what they can spend on adding to their children’s intellectual capital, or reduces their incentive to work hard to provide their offspring with the best the world’s educational institutions have to offer. I only wonder what economic or social purposes are served by preferential tax treatment that gilds the lily of birth.
What am I missing?
Irwin M. Stelzer, director of regulatory policy studies at the American Enterprise Institute, wrote about Tony Blair in last week’s issue.
