Difference between revisions of "Inheritance tax" - New World Encyclopedia

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[[Category:Economics]]
 
[[Category:Economics]]
  
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'''Inheritance tax''', '''estate tax''' and '''death duty''' are the names given to various [[tax|taxes]] which arise on the death of an individual. In United States tax law, there is a distinction between an estate tax and an inheritance tax: the former taxes the personal representatives of the deceased, while the latter taxes the beneficiaries of the estate. However this distinction does not apply in other jurisdictions. For example: if using this terminology in the UK, an inheritance tax would be equivalent to an estate tax.
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'''Inheritance tax''', '''estate tax''' and '''death duty''' are the names given to various [[tax|taxes]] which arise on the death of an individual. Technically, the ''inheritance tax'' and the ''estate tax'' are different although we shall  use the terms interchangeably, except where the distinction is important;  in the UK, an inheritance tax would be equivalent to an estate tax.  
  
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*In some jurisdictions, such taxes are known as '''inheritance tax''':
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In the U.S. an estate tax is paid out of the deceased’s estate before it is distributed. The same total tax is paid, therefore, whether there is one heir or dozens and the same tax is paid whether the heirs are rich or poor.
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**The [[Republic of Ireland]] (where it is a tax on beneficiaries).
 
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**The [[United Kingdom]]: see [[Inheritance Tax (United Kingdom)|Inheritance tax (United Kingdom)]].
 
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**Some states of the United States: see [[Estate tax in the United States#Inheritance tax at the state level|Inheritance tax at the state level]]:
 
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***[[Nebraska]]
 
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***[[New Jersey]]
 
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***[[Pennsylvania]]
 
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***[[Tennessee]]
 
  
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*In some jurisdictions the term used is '''estate tax''':
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==Brief overview of the Inheritance and/or Estate Tax==
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***[[Missouri]]
 
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***[[Virginia]]
 
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***[[Washington]]
 
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***[[West Virginia]]
 
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***[[Wisconsin]]
 
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***[[Wyoming]]
 
  
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*In some jurisdictions the term used is '''death duty''', and for historical reasons that term is used colloquially - although it is no longer correct legally - in the United Kingdom and some [[Commonwealth of Nations|Commonwealth]] nations.
 
  
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*In some jurisdictions the term is '''estate duty''':
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===Some basic definitions===
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**[[Hong Kong]]. See [[Estate Duty Ordinance Cap.111]]. However the tax was abolished in its entirety in the Budget Speech in 2006.
 
  
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*In some jurisdictions, death gives rise to a charge to '''[[stamp duty]]''':
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Depending on where you live the tax code may make reference to "inheritance tax", "estate tax" and even "death duty." 
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**[[Bermuda]]
 
  
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*In some jurisdictions, death gives rise to a charge to '''[[capital gains tax]]:
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In the United States, there is a difference between estate taxes and inheritance taxes.  Estate taxes are levied on representatives of the deceased person, while inheritance taxes are levied on the beneficiaries of an estate.
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**[[Canada]]. See [[Taxation in Canada]].
 
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::Where a jurisdiction has capital gains tax and inheritance tax (for example the United Kingdom) it is usual to exempt death from the capital gains tax.
 
  
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*In some jurisdictions death gives rise to the local equivalent of '''[[gift tax]]''' (see Austria, below, for example). This was the model in the United Kingdom during the period before the introduction of Inheritance Tax in 1986, where estates were charged to a form of gift tax called Capital Transfer Tax. Where a jurisdiction has a gift tax and an estate tax (for example the United States at federal level) it is usual to exempt death from the gift tax. Also, it is common for inheritance taxes to share some features of gift taxes, by taxing some transfers which happen during lifetime rather than on death. The United Kingdom, for example, taxes "lifetime chargeable transfers" (usually gifts to [[Trust law|trusts]]) to inheritance tax.
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Elsewhere in the world, the terms estate tax and inheritance tax are used interchangeably.
  
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*Non-English speaking jurisdictions naturally use non-English terminology:
 
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**[[Austria]] charges '''Erbschaftsteuer''', which has some of the features of a [[gift tax]].
 
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**[[Belgium]], a multilingual nation, uses the terms '''droits de succession''' and '''successierechten''', taxes on beneficiaries which are collected at the federal level but distributed to the regional level.
 
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**[[Czechia]] charges '''daň dědická''', taxes on beneficiaries.
 
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**[[France]] uses the term '''droits de succession''', taxes on beneficiaries.
 
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**[[Germany]] charges '''Erbschaftsteuer''', a tax on beneficiaries.
 
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**[[The Netherlands]] charges '''successierecht''', a tax on beneficiaries.
 
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**[[Switzerland]] has no '''Erbschaftsteuer''' / '''impôt successoral''' / '''imposta di successione''' at national level. However in the various cantons, three possibilities (a tax on the estate, a tax on the beneficiaries, or no tax) exist.
 
  
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*Some jurisdictions have never had estate or inheritance taxes, or have abolished them:
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An "inheritance tax" is paid by the heir and may vary according to the heir’s relation to the deceased, the heir’s  income and wealth, and the amount inherited. If an inheritance tax is, in any of the senses  above, progressive then the total tax paid will vary according to the number of heirs and their wealth.
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**[[Australia]]
 
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**[[British Virgin Islands]]
 
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**Some states of the United States: see [[Estate tax in the United States#Inheritance tax at the state level|Inheritance tax at the state level]]:
 
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***[[New Mexico]]
 
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***[[South Dakota]]
 
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***[[South Carolina]]
 
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***[[Utah]]
 
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**[[Vanuatu]]
 
  
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''This page is a modified [[WP:DAB|disambiguation]] page, which distinguishes not just between pages which would otherwise have the same name, but also between similar legal concepts which have different names in different jurisdictions.''
 
  
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{{UKtaxation}}
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The “estate tax” is a tax on net worth, the value of all property owned minus debt and any estate expenses. Essentially the tax is an “everything tax.” It’s a tax on cash and bank accounts, stocks, bonds, real estate, businesses, equipment and machinery, automobiles and other property, life insurance policies, artwork, even personal belongings.  
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In the [[United Kingdom]], '''Death Duty''' was first introduced as a tax on estates in [[England and Wales]] over a certain value from 1796, then called [[Succession duty|legacy, succession and estate duties]].  
 
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The value changed over time and the scope of estate duty was extended. By 1857 estates worth over £20 were taxable but duty was rarely collected on estates valued under £1500. Death duties were introduced in 1894, and for the next century were effective in breaking up large estates.  
 
  
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== Inheritance Tax ==
 
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Estate duty was replaced in 1975 by '''Capital Transfer Tax''', which was rebranded ''Inheritance Tax'' (IHT) in 1986. Partly due to the simple and widely-used methods which are available to [[Tax avoidance/evasion|avoid]] it, Inheritance Tax is a small, but by no means insignificant, revenue generator for the UK government, raising around £2,000,000,000 in 2001<ref>http://www.unbiased.co.uk/media/media-resources/press-releases/7-11-2001%5B60%5D accessed 22 may 2007</ref> and £3,600,000,000 in 2006. {{Fact|date=February 2007}}
 
  
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For the 6 April 2007 to 5 April 2008 [[tax year]], the IHT rate is 40% on the value, at death, of an individual's tax estate over £300,000. This figure is known as the nil rate band, and rises annually.
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In, both, the U.S. and Great Britain, egalitarians tend to prefer an inheritance tax since this gives the deceased an incentive to spread wealth across many heirs ( [[John Stuart Mill]] proposed an inheritance tax, for example) while pragmatists tend to support the estate tax because it is easier to administer and will tend to raise more revenue than the inheritance tax (precisely because it cannot be avoided by increasing the number of heirs).  
  
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In the 2007 budget report the Chancellor announced that this is to rise to £350,000 by 2010. This is to take into account the sharp rise in house prices in the united Kingdom over the past few years.<ref>http://money.uk.msn.com/budget/article.aspx?cp-documentid=4345307 accessed 21 March 2007</ref>
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====Calculation of Inheritance Tax in the U.S.====
  
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*Inheritance Tax Basis:
  
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=== Tax estate ===
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The first step used to determine any inheritance tax that might be due is to calculate the fair market value of the entire estate.  This would include cash, bank accounts, stocks and bonds, real state, insurance and similar items of value.  The total fair market value of all these items is termed the Gross Estate.
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The tax estate includes:
 
  
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# all of the [[deceased]]'s assets, whether [[real estate]] or [[Personal property|personal estate]], and includes even small-value items such as the contents of his or her home;
 
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# any gifts made by the deceased in the seven years before death;
 
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# some assets which were not owned by the [[deceased]] but which are affected by the death (the most common example is a [[life interest]] in a [[Trust (Law) non-USA|trust]], technically known as an [[interest-in-possession]]);
 
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# gifts with reservation of benefit. These are gifts where the legal ownership passes to the recipient. However, the donor continues to enjoy the benefit of the asset either rent free or at reduced cost. The seven year period outlined above does not begin counting down whilst a gift is considered to be under a reservation of benefit.
 
  
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There is also a charge on "lifetime chargeable transfers" into certain trusts (and a recalculation of those charges if the giver dies within seven years), and trusts themselves have an inheritance tax regime. See [[Taxation of trusts (United Kingdom)]].
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*Adjustments to Gross Estate:
  
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=== Deductions ===
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The next step would be to calculate any adjustments to the gross estate. Typical adjustments include the remaining balance on a mortgage or the fees associated with settling the estate.  This last item might include items such as estate administration fees or payments made to an attorney.  Finally, there is also a Marital Deduction that can be taken for property that is left to a surviving spouse.
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There are deductions for:
 
  
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# all assets left to a spouse or civil partner. However the exemption is limited to £55,000 where the deceased is domiciled in some part of UK and the surviving spouse/civil partner is domiciled outside of the UK <ref>s18 Inheritance Tax Act 1984</ref>;
 
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# all assets left to a charity registered in the UK.
 
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# some political donations;
 
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# gifts of up to £3000 in total in a given year[[http://www.hmrc.gov.uk/cto/glossary.htm#annualexemption]];
 
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# "small gifts" of up to £250 made to separate people;
 
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# some business assets (under [[Business Property Relief]] or "BPR");
 
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# some farmland (under [[Agricultural Property Relief]] or "APR").
 
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# gifts made out of income that do not impact upon the standard of living of an individual.
 
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# gifts made in contemplation of a marriage or civil partnership. The level of this deduction varies according to the relationship of the donor to person marrying or entering into a civil partnership.
 
  
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=== Minimising IHT ===
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*Net Value of Property:
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In order to [[Tax avoidance/evasion|avoid]] IHT, many people in the IHT bracket practise some or all of the following avoidance measures:
 
  
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* Outright gifts to another individual made during a person's lifetime are known as "potentially exempt transfers" or PETs. They are taxable if the person dies within seven years, but have the ''potential'' to become ''exempt'' from tax once seven years have gone by with the giver still alive. If the giver survives three years, the rate of tax on the PET reduces by one fifth (to 32%) and then by a further fifth on each of the subsequent anniversaries (to 24%, 16% then 8%) reaching 0% after seven years.  This is known as inheritance tax taper relief (not to be confused with the better-known capital gains tax taper relief).
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Once all the deductions have been taken from the gross estate, the remaining balance is considered the net value of the property - or the inheritance tax basis.
  
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* Gifting assets to a [[Trust (Law) non-USA|trust fund]] before death. (Some gifts of this kind, however, are disadvantageous as they amount to lifetime chargeable transfers on which IHT is paid straight away if more than £300,000 is gifted. This applies to many more trusts than previously under legislation announced in the 2006 budget. See [[Taxation of trusts (United Kingdom)]].)
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To calculate whether nor not any inheritance tax is due; the net value of the property must be subtracted from the inheritance tax credits appearing in the tables below. If the net estate is larger than the tax exclusion, then the federal income taxes due can be found on the standard tax brackets or tax rate tables published by the IRS.
  
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* Certain special types of trust, such as Discounted Gift Trusts and Gift & Loan Trusts, which allow for some planning whilst retaining some access to capital/income.
 
  
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* Charitable giving, which is IHT exempt.
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*Taxing of Life Insurance Proceeds:
  
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* Lifetime gifts within certain limits are completely exempt. These include any number of "small gifts" (up to £250), an annual amount of £3,000, all regular gifts from surplus income, and some wedding gifts.
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Life insurance proceeds paid to you are used in the calculation of the gross estate. The value of any insurance received is subject to the unified credits and inheritance tax exemptions explained later.  This last statement is true if you elect to receive the proceeds in the form of a single lump sum.
  
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* Upon death, passing non-taxable assets to the next generation (or to a discretionary trust for the benefit of the whole family) and therefore NOT to the spouse. To many people this seems [[counter-intuitive]] because they are aware that gifts to a spouse are '''IHT exempt''' and should therefore be maximised. However, if something is '''non-taxable''' on the first death it should not go to the spouse as it will merely increase his or her tax estate upon his or her later death. (The '''nil-band discretionary trust''', discussed below, is an example of this principle in action.)
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If you elect to receive life insurance proceeds in installments, then you need to separate the value of the insurance inherited from the total of all payments to determine your federal tax liability.
  
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==== Nil rate bands ====
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For example, you may be able to elect to receive a lump sum of $100,000 or $10,000 per month for 12 months. The difference between the lump sum payment and the money received is due to interest you are earning on the policy by taking installments.
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A person who has a tax estate less than the nil rate band may consider himself or herself outside the IHT bracket. However a couple with estates of less than ''double'' the nil rate band cannot consider themselves outside the IHT bracket unless they have taken specific action to ensure they use both nil rate bands. If they do the natural thing - the first of them to die leaving everything to the survivor - then they have effectively wasted that first nil rate band. The survivor will die owning everything, with only his or her ''one'' nil rate band to set against it.
 
  
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The most common means of ensuring that both nil rate bands are used is called a nil band discretionary trust (now more properly known as NRB Relevant Property Trust*). This is an arrangement in both wills which says that whoever is the first to die leaves their nil band to a discretionary [[Trust (Law) non-USA|trust]] for the family, and not to the survivor. The survivor can still benefit from those assets if needed, but they are not part of that survivor's tax estate.  
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In this example, you are receiving a total of 12 x $10,000 or $120,000, which is $20,000 higher than the lump sum of $100,000. This means that you would need to pay income tax on the $20,000 received in the form of interest income.
  
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For the above to work it is important that each partner has sufficient assets in their own name to cover the nil-band. Many married couples do not have sufficient spare assets to fund the NRB relevant property trust without using the matrimonial home. The home will normally be in joint names so the will needs to make provision for using the deceased's interest in the home in relation to the relevant property trust. If assets are all in one name, or in [[Concurrent estate|joint]] names, the arrangement may not work. This is often described, slightly inaccurately, as "equalisation."
 
  
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A gift is not valid for IHT purposes if the giver retains any benefit from it. There are quite complex and rigid rules which establish whether the giver has retained a benefit, and where there is a retention of benefit all IHT advantages from the gift are effectively lost.
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*Unified Credits, Gift Tax and Estate Tax:
  
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* Finance Act 2006
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The Unified Credit is used to eliminate or reduce your tax liability.  The credit applies to both gifts you may have received and estates that have been inherited.  The credit is termed a lifetime credit because as it is consumed by each gift or estate inherited the credit is reduced.  The lifetime credit applies to all inheritance or gifts received since 1977.
  
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==== Pre-owned assets ====
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The lifetime gift tax exclusion you can take in 2006 is $1,000,000.  Another way of looking at the same information is to state that you have a $345,000 tax credit that you can apply to any income taxes owed on gifts.
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The [[Finance Act 2004]] introduced an [[income tax]] regime known as [[pre-owned asset tax]] which aims to reduce the use of common methods of IHT avoidance.<ref>[http://www.hmrc.gov.uk/budget2004/revbn40.htm REV BN 40: Tax Treatment Of Pre-Owned Assets]</ref>
 
  
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== Criticism ==
 
  
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Dr.Barry Bracewell-Milnes authored ''Euthanasia for Death Duties - Putting Inheritance Tax Out of Its Misery'', which was published by [[The Institute of Economic Affairs]], Westminster, 2002, ISBN 0-255-36513-6
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===Rising problems with Inheritance tax in OECD===
  
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In August 2006, former [[Cabinet of the United Kingdom|Cabinet minister]] [[Stephen Byers]] called for IHT to be abolished in an article in the [[Sunday Telegraph]].<ref>[http://news.bbc.co.uk/1/hi/uk_politics/5267836.stm].
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"Inheritance tax" used to make the news only when it forced once super-rich dynasties to flog their heirlooms after the head of the family died. But suddenly, death is getting expensive for a much larger number of Europeans, and that's starting to attract the attention of politicians and headline writers across the Continent.  
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</ref>
 
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On 16 October 2006, Philip Johnston, writing in ''[[The Daily Telegraph]]'' had a scathing leading article against Inheritance Taxes and called for [[David Cameron]], new leader of the [[Conservative Party (UK)]], to announce the demise of a catch-all Inheritance Tax as a main plank in that party's next manifesto.
 
  
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{{otheruses4|Estate tax in the United States|other countries|Inheritance tax}}
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Furious discussions about whether to limit, amend or suppressinheritance taxes broke out last week in both Britain and France.  
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{{UStaxation}}
 
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The '''estate tax''' in the [[United States]] is a [[tax]] imposed on the transfer of the "taxable [[Estate (law)|estate]]" of a deceased person, whether such property is transferred via a [[will (law)|will]] or according to the state laws of [[intestacy]]. The estate tax is one part of the ''Unified Gift and Estate Tax'' system in the United States. The other part of the system, the [[gift tax]], imposes a tax on transfers of property during a person's life; the gift tax prevents avoidance of the estate tax should a person want to give away his/her estate just before dying.
 
  
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In addition to the federal government, many states also impose an estate tax, with the state version called either an estate tax or an [[inheritance tax]]. Since the 1990s, the term "[[Estate tax (United States)#The "Death Tax" neologism|death tax]]" has been widely used by those who want to eliminate the estate tax, because the terminology used in discussing a political issue affects popular opinion.<ref>[http://www.60plus.org/deathtax.asp?docID=347]</ref>
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In Italy, meanwhile, there's controversy and skepticism about plans by the new government[an error occurred while processing this directive] of Romano Prodi to reinstate the inheritance tax abolished by former Prime Minister Silvio Berlusconi in one of his first acts on taking office in 2001.  
  
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If an asset is left to a spouse or a charitable organization, the tax usually does not apply. The tax is imposed on other transfers of property made as an incident of the death of the owner, such as a transfer of property from an [[intestate]] estate or trust, or the payment of certain [[life insurance]] benefits or financial account sums to beneficiaries.  
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The debate is erupting now because death duties of up to 40%, once paid only by the affluent, are starting to affect a growing number of middle-class Europeans — and will likely hit millions more in the decade to come.  
  
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==Federal estate tax==
 
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The Federal ''estate tax'' is imposed "on the transfer of the taxable estate of every decedent who is  citizen or resident of the United States."<ref>See {{usc|26|2001(a)}}.</ref> The starting point in the calculation is the "gross estate." Certain deductions (subtractions) from the "gross estate" amount are allowed in arriving at a smaller amount called the "taxable estate."
 
  
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===The "gross estate"===
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"……'''''Inheritance tax used to be a problem for the rich. Now it's a problem for you and me'''''….." says Anne Young, a tax expert at the Edinburgh financial-services firm Scottish Widows, who calculates that about 1 in 3 of Britain's 24 million households now have estates that would fall within the taxman's reach. Young herself admits she has an inheritance-tax "problem."
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The "gross estate" for Federal estate tax purposes often includes more property than that included in the "probate estate" under the property laws of the state in which the decedent lived at the time of death. The starting point for the calculation of the estate tax is the value of the "gross estate"<ref>Defined at {{usc|26|2031}} and {{usc|26|2033}}.</ref>, as modified by certain other statutory provisions. The gross estate (before the modifications) may be considered to be the value of all the property interests of the decedent at the time of death. To these interests are added the following property interests generally not owned by the decedent at the time of death:
 
  
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*the value of property to the extent of an interest held by the surviving spouse as a "dower or curtesy"<ref>See {{usc|26|2034}}.</ref>;
 
  
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*the value of certain items of property in which the decedent had, at any time, made a transfer during the three years immediately preceding the date of death (i.e., even if the property was no longer owned by the decedent on the date of death), other than certain gifts, and other than property sold for full value<ref>See {{usc|26|2035}}.</ref>;
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Blame the explosion of house prices. Unlike their parents, European baby boomers tend to own their homes. As prices have soared over the past few years in almost every country except Germany, these homeowners have enjoyed big increases in the value of their total assets. But in many cases, the rise has pushed their net worth over the national minimum thresholds for inheritance tax, which haven't been adjusted in step with the housing boom. The result: almost anyone owning a detached house in London or southeast England is already well over the U.K. tax-free limit on estates of $540,000.  
  
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*the value of certain property transferred by the decedent before death for which the decedent retained a "life estate," or retained certain "powers"<ref>See {{usc|26|2036}}.</ref>;
 
  
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*the value of certain property in which the recipient could, through ownership, have possession or enjoyment only by surviving the decedent<ref>See {{usc|26|2037(a)(1)}}.</ref>;
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France is even tougher. There, inheritance tax is levied in theory from the first euro passed on, but a series of tax-free thresholds apply to family members, including a €50,000 one for children of the deceased. The value of even a modest two-bedroom apartment in central Paris is enough to push families into a 30% tax bracket (the top rate for them is 40%, for estates valued at over €1.7 million).  
  
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*the value of certain property in which the decedent retained a "reversionary interest," the value of which exceeded five percent of the value of the property<ref>See {{usc|26|2037(a)(2)}}.</ref>;
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For nonfamily members and unmarried partners, the situation is even more complicated, with inheritance tax rising as high as 60%. And unlike many other countries, where the tax is levied when assets are handed down a generation, husbands and wives in France are subject to death duties on what they inherit from their spouses.  
  
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*the value of certain property transferred by the decedent before death where the transfer was revocable<ref>See {{usc|26|2038}}.</ref>;
 
  
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*the value of certain annuities<ref>See {{usc|26|2039}}.</ref>;
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In the U.S., the subsequent administrations to Ronald Reagan's one have left the following legacy concerning the Inheritance Tax:
  
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*the value of certain jointly owned property, such as assets passing by operation of law or survivorship, i.e. [[joint tenants with rights of survivorship]] or [[tenants by the entirety]], with special rules for assets owned jointly by spouses.<ref>See {{usc|26|2040}}.</ref>;
 
  
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*the value of certain "powers of appointment"<ref>See {{usc|26|2041}}.</ref>;
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*The rate was scheduled to fall to 50 percent by 1993, however, ERTA ( i.e. Economic Recovery Act of 1981 )  had scheduled the rate to fall to 50 percent by 1985, but this reduction has been twice delayed and pushed off to the farther future; the general public may never see the 50 percent rate promised in ERTA.  
  
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*the amount of proceeds of certain life insurance policies<ref>See {{usc|26|2042}}.</ref>.
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*Marginal rates begin at 37 percent after the first $600,000.  
  
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The above list of modifications is not comprehensive.
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*There is a peculiar non-linearity in the schedules so that the tax rises to 60 percent between $10,000,000 and $21,040,000 but then falls to 55 percent again. It’s unclear why this non-linearity exists.
  
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As noted above, life insurance benefits may be included in the gross estate (even though the proceeds arguably were not "owned" by the decedent and were never received by the decedent). Life insurance proceeds are generally included in the gross estate if the benefits are payable to the estate, or if the decedent was the owner of the life insurance policy or had any "incidents of ownership" over the life insurance policy (such as the power to change the beneficiary designation). Similarly, bank accounts or other financial instruments which are "payable on death" or "transfer on death" are usually included in the taxable estate, even though such assets are not subject to the [[probate]] process under state law.
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==Economics of minimal Inheritance Taxes==
  
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===Deductions and the taxable estate===
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Before we enter this domain, a few excerpts  should precede it:
  
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Once the value of the "gross estate" is determined, the law provides for various "deductions" (in Part IV of Subchapter A of Chapter 11 of Subtitle B of the [[Internal Revenue Code]]) in arriving at the value of the "taxable estate." Deductions include but are not limited to:
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“…..This does not imply that once-earned wealth perpetuates itself forever. On the contrary, even if a fortune were completely immune from risk it would tend to quickly dissipate so long as there is more than one heir in each generation. In a free market wealth is continually changing hands…… .….Increasing and even maintaining a fortune requires entrepreneurial skill……” ( von Mises 1981, pp. 338–40 ).  
  
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*Funeral expenses, administration expenses, and claims against the estate<ref>See {{usc|26|2053}}.</ref>;
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“…….Consider how much easier it is to waste a million dollars than it is to make a million dollars. Nevertheless, wealth will typically last more than one generation so it is reasonable to argue that at least two generations of heirs are significantly harmed by the estate tax……( ibid.).
  
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*Certain [[charitable organization|charitable]] contributions<ref>See {{usc|26|2055}}.</ref>;
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“…In modern times the funds raised by the estate and gift tax have accounted for only a small proportion of government revenue…In 1990 death and gift taxes raised just over $15 billion in revenue, approximately $11 billion of which  was because of the Federal estate and gift tax the remainder because of state death and gift taxes; as seen in Statistical Abstract of the United States, 1990…” ( Tabarrok, 1997) .
  
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*Certain items of property left to the surviving spouse<ref>See {{usc|26|2056}}.</ref>.
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===Inter-generation transfers and “working” capital accumulation===
  
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*Beginning in 2005, inheritance or estate taxes paid to states or the District of Columbia<ref>See {{usc|26|2058}}.</ref>.
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In spite of the best efforts of social engineers, the estate tax has not had a revolutionary effect on aggregate  income inequality, although some families have been devastated by the tax. In fact, both,
 +
[[Adam Smith]] and [[David Ricardo]] ( Smith, 1904 ; Ricardo, 1917)  argued that the inheritance tax reduced savings, and, in causal relation,  future capital investments.
  
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Of these deductions, the most important is the marital deduction for property passing to (or in certain kinds of trust for) the surviving spouse, because it can eliminate any federal estate tax for a married decedent.  However, this unlimited deduction does not apply if the surviving spouse (not the decedent) is not a U.S. citizen<ref>See {{usc|26|2056(d)}}.</ref>.  A special trust called a Qualified Domestic Trust or QDOT must be used to obtain an unlimited marital deduction for otherwise disqualified spouses<ref>See {{usc|26|2056A}}.</ref>;.
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Since the 1950s, however, the dominant opinion among economists has been that the bequest motive has little to do with saving and capital accumulation.  So even if true, the slight sapping of savings by
 +
estate taxation was not to be worried about. Recent work, however, challenges the dominant view of
 +
savings ( see Kotlikoff and Summers, 1981) .  
  
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===Tentative tax===
+
Strictly speaking, however,  the modern bequest theory is an inter-generational transfer theory of saving.  Hence, a tax on the transfer of property between the generations can affect savings by changing the behavior of the bequestor or the heir. The effect on the bequestor is composed of two parts:
  
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The tentative tax base is the sum of the taxable estate and the "adjusted taxable gifts" (i.e., taxable gifts made after 1976) and the tentative tax is then calculated by applying the following tax rates:
+
*the price effect and  
  
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For amounts not greater than $10,000, the tax liability is 18% of the amount.
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*the wealth effect.  
  
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For amounts over $10,000 but not over $20,000, the tentative tax is $1,800 plus 20% of the excess over $10,000.
+
The tax raises the price of bequests and therefore reduces the desired bequest.  The effect on savings, however, is ambiguous.  
  
−
For amounts over $20,000 but not over $40,000, the tentative tax is $3,800 plus 22% of the excess over $20,000.
+
Imagine that a man wishes to bequeath an estate of $1 million to his daughter. If there is no tax he must save $1 million, but if there is a tax of 50 percent and he still wishes to bequeath $1 million he must increase his savings to $2 million.
  
−
For amounts over $40,000 but not over $60,000, the tentative tax is $8,200 plus 24% of the excess over $40,000.
+
In most circumstances the bequestor will want to reduce the amount of bequest, but so long as the
 +
reduction in final bequest is less than 50 percent the price effect works to increase saving. The price effect can be summarized in terms of elasticities. If the demand to give bequests is inelastic the price effect works to increase savings.
  
−
For amounts over $60,000 but not over $80,000, the tentative tax is $13,000 plus 26% of the excess over $60,000.
+
Little data exist on this elasticity but a demand curve must be elastic above some price, otherwise a consumer could be made to spend all of his income on the single taxed good ( Wagner 1977, p. 19 ). At today’s rates of 55 percent the demand for bequests is probably elastic and there is little doubt that if the rates were raised by any significant degree the amount of savings would be reduced.
  
−
For amounts over $80,000 but not over $100,000, the tentative tax is $18,200 plus 28% of the excess over $80,000.
+
Reinforcing the reduced savings because of the price effect is the wealth effect. For a given size of
 +
bequest, an increase in the estate tax is equivalent to a reduction in wealth. The desire to give bequests decreases (increases) as wealth decreases (increases). In other words, bequests are a “normal” good.  
  
−
For amounts over $100,000 but not over $150,000, the tentative tax is $23,800 plus 30% of the excess over $100,000.
+
The effect of estate taxation on the heir’s savings decision is important although rarely discussed
 +
even though it formed the focus of Ricardo’s comments ( Ricardo, 1917 ) .  
  
−
For amounts over $150,000 but not over $250,000, the tentative tax is $38,800 plus 32% of the excess over $150,000.
+
An inheritance is a large, one-time, increase in wealth. Income smoothing requires that the bulk of this wealth be saved. A decrease in the heir’s inheritance is therefore ipso facto, a large decrease in savings.  
  
−
For amounts over $250,000 but not over $500,000, the tentative tax is $70,800 plus 34% of the excess over $250,000.
+
Indeed, if the bequestor and heir have similar wealth and value scales, the heir will want to save the principal portion of the estate so that it can be passed on to his own heirs. This is what accounts for the fact that family fortunes are typically the accumulated savings of more than one generation.  
  
−
For amounts over $500,000 but not over $750,000, the tentative tax is $155,800 plus 37% of the excess over $500,000.
+
Bequest-saving tends to be long-term and continuous and therefore allows for what [[F.W. Taussig]]  called “…sustained accumulation and permanent investment…..” ( Taussig, 1920, p. 249) .This is especially true when savings are passed along in the form of family businesses.
  
−
For amounts over $750,000 but not over $1,000,000, the tentative tax is $248,300 plus 39% of the excess over $750,000.
+
====Questions of morality and efficiency of inheritance====
 +
 +
Those who are able to bequeath a material inheritance are also often able to bequeath a sound moral and educational inheritance. Along with pecuniary and physical capital the founding generation bequeaths human capital. In a capitalist society, therefore, the institution of inheritance is more than a moral institution, it is part of the process whereby wealth is transferred to those who can best use it to serve the wishes of consumers.
  
−
For amounts over $1,000,000 but not over $1,250,000, the tentative tax is $345,800 plus 41% of the excess over $1,000,000.
+
Consider the following three proposals and let us try to assess  which will cause the most efficient distribution of wealth according to the wishes of consumers:
  
−
For amounts over $1,250,000 but not over $1,500,000, the tentative tax is $448,300 plus 43% of the excess over $1,250,000.
+
*(1) Inheritance according to the will of the owner,  
  
−
For amounts over $1,500,000, the tentative tax is $555,800 plus 45% of the excess over $1,500,000.
+
*(2) Inheritance to a randomly picked individual, or
  
−
For years before 2007, additional tax brackets applied for amounts over $2,000,000 with marginal rates of up to 55%.
+
*(3) The state takes the inheritance as tax revenue ( see Rothbard, 1970 in the below note ) ?
  
−
The tentative tax is reduced by gift tax that would have been paid on the adjusted taxable gifts, based on the rates in effect on the date of death (which means that the reduction is not necessarily equal to the gift tax actually paid on those gifts).
+
In the long run only the market can reveal who possesses the entrepreneurial spark. But when wealth must be passed from one generation to another the institution of inheritance seems to be both moral and efficient.
  
−
Although the above tax table looks like a system of progressive tax rates, there is a unified credit against the tentative tax which effectively eliminates any tax on the first $2,000,000 of the estate (or the first $2,000,000 on a combination of taxable gifts during lifetime and a taxable estate at death), so the federal estate tax is effectively a flat tax of 45% once the unified credit exclusion amount has been exhausted.
 
  
−
===Credits against tax===
+
====Problems in government investing of the inheritance tax ====
  
−
There are several credits against the tentative tax, the most important of which is a "unified credit" which can be thought of as providing for an "exemption equivalent" or [[tax exemption|exempted value]] with respect to the sum of the taxable estate and the taxable gifts during lifetime.
+
One reason most neo-classical economists ignore the effect of the estate tax on the heir’s saving
 +
is the argument that the government can also “save” the estate tax by investing it in capital
 +
projects.  
  
−
For a person dying during 2006, 2007, or 2008, the "applicable exclusion amount" is $2,000,000, so if the sum of the taxable estate and the "adjusted taxable gifts" made during lifetime is $2,000,000 or less, there is no federal estate tax to pay. According to the [[Economic Growth and Tax Relief Reconciliation Act of 2001]], the applicable exclusion will increase to $3,500,000 in 2009, the estate tax is repealed in 2010, but then the act "sunsets" in 2011 and the estate tax reappears with an applicable exclusion amount of only $1,000,000 (unless Congress acts before then).
+
From that does not immediately follows that if the bequestor reduces his savings in the face of the estate tax, savings must decline regardless of what the government does with the tax revenue. At best, this objection, even if accepted, blunts but does not overturn the negative effect on savings derived from the behavior of bequestors.
  
−
Do not confuse the estate tax credit or exemption equivalent with the federal gift tax credit or exemption equivalent. The gift tax exemption is frozen at $1,000,000 and does not increase, as does the estate tax exemption.
 
  
−
If the estate includes property that was inherited from someone else within the preceding 10 years, and there was estate tax paid on that property, there may also be a credit for property previous taxed.
+
But, generally, there are several flaws with this argument:
  
−
Before 2005, there was also a credit for non-federal estate taxes, but that credit was phased out by the [[Economic Growth and Tax Relief Reconciliation Act of 2001]].
+
*First, the wealthy tend to have low rates of time preference which allows family fortunes to be
 +
invested in long-term projects see the above Taussig’s “sustained accumulation and permanent investment” ( Lawrence, 1991) . Even assuming that governments were to “invest” the proceeds of the tax rather than spend it on redistribution and pork barrel projects, governments are dominated by politicians whose time horizons are measured in years to the next election rather than in decades and generations.  
  
−
===Requirements for filing return and paying tax===
+
*Second, and more fundamentally, there is a crucial difference between government investment
 +
and private sector investment. Only in the latter case can it be concluded that investments are welfare-enhancing ( Rothbard 1956 ).  Private sector savings are necessarily allocated to maximize consumer and producer  well-being. Government savings are allocated according to arbitrary political fiat. [[Rothbard]] (1970) has made a strong case that so called government investment is better understood as consumption by government officials rather than savings.
  
−
For estates larger than the current federally exempted amount, any estate tax due is paid by the [[executor]], other person responsible for administering the estate, or the person in possession of the decedent's property.  That person is also responsible for filing a Form 706 return with the [[Internal Revenue Service]]. The return must contain detailed information as to the valuations of the estate assets and the exemptions claimed, to ensure that the correct amount of tax is paid.
+
Adam Smith’s distinction between unproductive and productive labor was never more apt than when he wrote:
  
−
===Exemptions and tax rates===
+
“…..All taxes upon the transference of property . . . are all more or less unthrifty taxes that increase the revenue of the sovereign, which seldom maintains any but unproductive laborers; at the expense of the capital of the people, which maintains none but productive….”( Smith, 1904 ).
−
<div style="float:left; width:55%;">
 
−
As noted above, a certain amount of each estate is exempted from taxation by the federal government. Below is a table of the amount of exemption by year an estate would expect. Estates above these amounts would be subject to estate tax, but only for the amount above the exemption.
 
  
−
For example, assume an estate of $3.5 million in 2006. There are two beneficiaries who will each receive equal shares of the estate. The maximum allowable credit is $2 million for that year, so the taxable value is therefore $1.5 million. Since it is 2006, the tax rate on that $1.5 million is 46%, so the total taxes paid would be $690,000. Each beneficiary will receive $1,000,000 of untaxed inheritance and $405,000 from the taxable portion of their inheritance for a total of $1,405,000. This means that they would have paid (or, more precisely, the estate would have paid) a taxable rate of 19.7%.
+
To evaluate the effect of higher estate ( or inheritance )  taxes, it is therefore necessary to examine the life cycle theory ( see the next paragraph ). Traditionally, many economists believed that the most important reason people saved was to give bequests. [[Alfred Marshall]] (1949, p. 227) held that “….family affection is the main motive for saving…..”
  
−
As shown, the 2001 tax act will repeal the estate tax for one year—2010—and then readjust it in 2011 to the year 2001 level.
+
[[Schumpeter]] (1942, p. 160) called the “….family motive” the “mainspring” of savings…..”, and F.W. Taussig (1920, p. 249) argued that for long-term savings “…..the main motives are domestic affection and family ambition…….”
  
−
</div><div style="float:right; width:40%; margin: 0.5em; padding: 0.5em; border: 1px solid #8888aa; ">
+
Elsewhere Taussig (1920, p. 509) called inheritance “……the great engine for the maintenance of capital……” and, in his highly regarded principles text, [[Frank A. Fetter]] (1913, p. 371) argued that “…….Much of the existing wealth probably never would have been created if men did not have [the] right of gift…...”
−
<table border="0" cellpadding="2" cellspacing="0">
 
−
<tr>
 
−
<td rowspan="2">Year
 
−
</td>
 
−
<td><br/></td>
 
−
<td colspan="2" rowspan="2">
 
−
<p align="center">Exclusion<br/>Amount
 
−
</p>
 
−
</td>
 
−
<td colspan="2" rowspan="2">
 
−
<p align="center">Max/Top<br/>
 
−
tax rate</p>
 
−
</td>
 
−
</tr>
 
−
<tr>
 
−
<td>&nbsp; </td>
 
−
</tr>
 
−
<tr>
 
−
<td>2001</td>
 
−
<td><br/></td>
 
−
<td >$675,000</td>
 
−
<td><br/></td>
 
−
<td >55%</td>
 
−
<td><br/>
 
−
</td>
 
−
</tr>
 
  
−
<td>2002</td>
+
In fact, the entire capitalist order for Schumpeter (1942, p.160 and passim) is founded on the family motive. “…….When the capitalist-entrepreneur-bourgeois is sundered from longterm family ties he becomes, to borrow a phrase, a wage slave or bureaucrat-cog easily crushed by the state and its
−
<td><br/></td>
+
philosophical apparatus……..” ( ibid. ).
−
<td >$1 million</td>
 
−
<td><br/></td>
 
−
<td >50%</td>
 
−
<td><br/>
 
−
</td>
 
  
−
<td><br/></td>
+
====Cycle Theory of Saving====
−
</tr>
 
−
<tr>
 
−
<td>2003</td>
 
−
<td><br/></td>
 
−
<td>$1 million</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>49%</td>
 
−
<td><br/>
 
−
</td>
 
  
−
<td><br/></td>
+
The theory of saving was the central component of post World War II Keynesian macroeconomics
−
</tr>
+
but the bequest theory was completely abandoned during this period. In its place was put the life cycle theory of saving because of Modigliani and Brumberg (1954) . The life cycle theory places the main motivation for saving on the desire to provide for retirement. The theory implies that savings should follow a “hump” pattern.
−
<tr>
 
−
<td>2004</td>
 
−
<td><br/></td>
 
−
<td>$1.5 million</td>
 
−
<td><br/></td>
 
−
<td>48%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
Young adults begin the saving process by borrowing; as their career stabilizes they pay off old debts
−
</tr>
+
and begin to save, then, when retirement begins, they draw down their savings until they die. In the
−
<tr>
+
simple model, everyone wishes to consume up to the moment of death and then die penniless. In more complicated models a bequest motive is tacked on as an afterthought.
−
<td>2005</td>
 
−
<td><br/></td>
 
−
<td>$1.5 million</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>47%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
Yet, far before the life cycle theory was born, Alfred Marshall ( 1949, p. 228) recognized an important fact which casts doubt on the theory. He noted that “…. men seldom spend, after they have retired from work, more than the income that comes in from their savings, preferring to leave their stored up wealth intact for their families……..” ( ibid. )
−
</tr>
 
−
<tr>
 
−
<td>2006</td>
 
−
<td><br/></td>
 
−
<td>$2 million</td>
 
−
<td><br/></td>
 
−
<td>46%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
In other words, the elderly do not dissave as the life cycle theory predicts. Marshall’s observation has been verified by a number of studies in recent years.36) Far from dying penniless, the elderly often die richer than at any other point in their life. A related point is the low demand among the elderly for annuities and reverse mortgages. Some economists have claimed that uncertainty about time of death explains why the elderly do not dissave.
−
</tr>
 
−
<tr>
 
−
<td>2007</td>
 
−
<td><br/></td>
 
−
<td>$2 million</td>
 
−
<td><br/></td>
 
−
<td>45%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
But if this were the motivation for maintaining income in old age we would expect the elderly to invest in annuities and reverse mortgages. An annuity is like life insurance in reverse. A large and certain payment is made today in return for an income stream which lasts until death. Similarly, in a reverse mortgage the buyer promises to will his house to a firm in return for an income stream which is paid until death.
−
</tr>
 
−
<tr>
 
−
<td>2008</td>
 
−
<td><br/></td>
 
−
<td>$2 million</td>
 
−
<td><br/></td>
 
−
<td>45%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
If they wanted to do so, the elderly could use these devices to consume their wealth without fear of being destitute in the event that they live longer than expected. The fact that these markets are relatively small suggests that the main reason the elderly do not dissave is to make bequests. Instead of buying annuities, which the life cycle theory predicts, many elderly persons are trying to get rid of annuities the government has forced them to buy.  
−
</tr>
 
−
<tr>
 
−
<td>2009</td>
 
−
<td><br/></td>
 
−
<td>$3.5 million</td>
 
−
<td><br/></td>
 
−
<td>45%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
One of those annuities is Social Security that taxes income in early periods and then returns that income in later periods in annuitized form. Social Security changes not only the amount of saving but the type of saving which occurs—it favors annuity saving rather than saving in the form of bequestable wealth.
−
</tr>
 
−
<tr>
 
−
<td>2010</td>
 
−
<td><br/></td>
 
−
<td>repealed</td>
 
−
<td><br/></td>
 
−
<td>0%</td>
 
−
<td><br/></td>
 
  
−
<td><br/></td>
+
Imagine that a man has paid $100,000 into Social Security. After he retires, this money begins to return to him in periodic payments. If he lives long enough he may even see the entire $100,000 again, but if he dies after consuming only half of his $100,000 payment he cannot bequest the remaining $50,000.
−
</tr>
 
−
<tr>
 
−
<td>2011</td>
 
−
<td><br/></td>
 
−
<td>$1 million</td>
 
−
<td><br/></td>
 
−
<td>55%</td>
 
−
<td><br/></td>
 
−
<td><br/></td>
 
  
−
</tr>
+
In addition to these theoretical arguments, recent econometric work by Kotlikoff and Summers (1981) indicates that the stock of wealth is far too large to be accounted for by life cycle reasons. Although hotly debated and challenged, the bequest wealth is now recognized to be much more important than previously thought.
  
−
</table>
+
Hence, the theoretical and empirical shortcomings of the life cycle theory indicate that the bequest motive is an important determinant of savings. This means that far from being negligible the estate tax and gift tax could significantly reduce total savings. If the current exemption were to be lowered the increase in the estate tax base would be considerable and savings could be even more adversely
−
</div><br clear="all">
+
affected.
  
−
==Inheritance tax at the state level==
+
===Ethical Justifications of Inheritance Tax===
  
−
Many U.S. states also impose their own estate or inheritance taxes (see [[Ohio estate tax]] for an example).  Some states "piggyback" on the federal estate tax law in regard to estates subject to tax (i.e., if the estate is exempt from federal taxation, it is also exempt from state taxation).  Some states' estate taxes, however, operate independently of federal law, so it is possible for an estate to be subject to state tax while exempt from federal tax.
+
=====Equality of Opportunity====     
  
−
==Tax avoidance==
+
Economists and other writers often ethically rationalize the estate and inheritance taxes by appealing
−
Estate tax rates and complexity have driven a vast array of support services to assist clients with a perceived eligibility for the estate tax to develop [[tax avoidance]] techniques. Many [[life insurance|insurance companies]] maintain a network of life insurance [[agency (law)|agent]]s, all providing [[Certified Financial Planner|financial planning services]], guided to avoid paying estate taxes.  Brokerage and financial planning firms also use [[estate planning]], including estate tax avoidance, as a marketing technique. Many [[law firm]]s also specialize in estate planning, tax avoidance, and minimization of estate taxes.  
+
to the principle of equality of opportunity. Economist and Nobel Prize winner [[James Buchanan]], for example, argue that”…… a guarantee of “some” equality of opportunity is inherent in the political philosophy of the free society…….” ( Buchanan, 1975, p. 303 )
  
−
The first technique many use is to combine the tax exemption limits for a husband and wife either through a [[will]] or create a [[living trust]]. Many, but not all, other techniques do not really avoid the estate tax, rather they provide an efficient and leveraged way to have liquidity to pay for the tax at the time of death. It is very important for those whose primary wealth is in a business they own, or real estate, or stocks, to seek professional advice or they may run the risk of the estate tax forcing their heirs to sell these things at an inopportune time. In one popular scheme, an irrevocable life insurance trust, the parents give their kids (within the allowed yearly gift tax limit) money to buy life insurance on the parents in an irrevocable life insurance trust. Structured in this way, life insurance is free of estate tax. However, if the parents have a very high net worth and the life insurance policy would be inadequate in size due to the limits in premiums, a charitable remainder trust may be used. This is where a large asset is flagged to be donated to a charity, sold, and invested. The investment income buys life insurance but the principal goes to the charity when the parents die. Meanwhile the children get the full amount as well in life insurance proceeds. This is a large reason for many charitable gifts, and proponents of the estate tax argue the tax should be maintained to encourage this form of charity.
+
And Groves (1939, p. 248) correctly notes that equality of opportunity is often accepted as desirable “by the most ‘rugged’ of individualists.”
  
−
==Debate==
+
Closely linked with the idea of equality of opportunity is the principle of desert. Many who reject as morally repugnant confiscatory income taxes accept the inheritance tax because the individual
 +
does not “earn” his inheritance and is therefore undeserving. Harlan Read (1918, p. 279) stated the thesis boldly in his Abolition of Inheritance: “…….All estates are unearned by the heirs and should therefore, be taken by taxation……..”
  
−
===Arguments against===
 
−
{{originalresearch}}
 
−
One argument against the estate tax is that the tax obligation in itself can assume a disproportionate role in planning, possibly overshadowing more fundamental decisions about the underlying assets. In certain unfortunate cases, this is claimed to create an undue burden. For example, pending estate taxes could become an artificial disincentive to further investment in an otherwise viable business &ndash; increasing the appeal of tax- or investment-reducing alternatives such as liquidation, downsizing, divestiture, or retirement. This could be especially true when an estate's value is about to surpass the exemption equivalent amount. Older individuals owning farms or small businesses, when weighing ongoing investment risks and marginal rates of return in light of tax factors, may see less value in maintaining these taxable enterprises. They may instead decide to reduce risk and preserve capital, by shifting resources, liquidating assets, and using tax avoidance techniques such as insurance policies, gift transfers, trusts, and tax free investments. <ref>[http://www.heritage.org/Research/Taxes/BG1428.cfm]</ref>
 
  
−
Moreover, not all taxpayers have equal access to (or trust in) estate planning services; an aging farm or business owner (perhaps a Depression survivor) might not understand the consequences of leaving inheritance issues to surviving family members, or even of [[intestacy]]. A policy that creates an uneven tax burden, even when due to ignorance or inaction, can raise the appearance of unfairness.
+
From the correct idea that a man deserves what he earns he draws the incorrect conclusion that a man does not deserve what he does not earn.
  
−
Opponents also argue that the Federal estate tax rate is effectively higher because it is calculated based on the total estate rather than as a percentage of the amount actually transferred to heirs. For example, an estate worth $3.5 million with 2 heirs paid $940,000 federal estate tax in order to transfer $1,280,000 to each heir, suggesting an effective transfer tax rate of 36.7% for them rather than the 26.8% on the estate as a whole. Similarly, at the limit, the top federal tax rate of 50% on the estate value would imply a transfer tax rate of 100% of the amount transferred to 2 heirs. (For non-cash assets such as real estate or securities, market fluctuations after death can lead to tax/asset mismatches and a higher effective rate of taxation for heirs; this affected some estates valued during the economic downturn in 2001-2002.) The high effective transfer tax rate has prompted many wealthy benefactors to make sizable gifts during their lifetime, paying a [[gift tax]] on the amount transferred, rather than allow the whole amount to be taxed at the estate level.
+
The principle of equality of opportunity and the principle of desert are both inimical to the free society. There are, however, at least two uncertainties in these moral principles:
  
−
Some argue that the estate tax creates a potential for double and triple taxation, that is, taxation on assets which have already been taxed.  Double taxation occurs on earned income, and by imposing capital gains tax on the returns after earned income is reinvested in new ventures, stocks, bonds, and savings.  However, the capital gains on those reinvested proceeds have never been taxed in the first place, because the income tax system does not recognize income until the asset (here a share of stock) is sold or transferred. Without the estate tax, the alternative is to treat the transfer of ownership of the stock at death as a sale and impose the capital gains tax then.  In this manner, the estate tax would not be seen as an additional tax, but the first tax upon the unrealized capital gains.
+
*1)Stated in a certain fashion it appears inherently just and when contrasted with equality of condition or outcome it appears manifestly superior. Equality of opportunity is often presented in the context of lack of opportunity.  
  
−
<div style="font-family:courier, courier new, lucida console; float:right; width:60%; margin:.5em; padding: 0.5em; border: 1px solid #8888aa;">
+
Typical argument: The intelligent child of the inner city who is unable to excel because he lacks a good education is contrasted with the luckier child of the suburb. Why should forces for which the child is not responsible and does not control be such a large factor in his life? Why are otherwise identical individuals placed in such differing circumstances?
−
<table border="0" cellpadding="2" cellspacing="0">
 
−
<tr>
 
−
<td rowspan="2">Estate value<br/>(Millions)
 
−
</td>
 
−
<td><br/></td>
 
−
<td colspan="2" rowspan="2">
 
−
<p align="center">Number of <br/>
 
−
returns</p>
 
−
</td>
 
−
<td colspan="2" rowspan="2">
 
−
<p align="center">Average tax<br/>
 
−
(in thousands)</p>
 
−
</td>
 
−
<td colspan="2" rowspan="2">
 
−
<p align="center">Effective<br/>
 
−
tax rate</p>
 
−
</td>
 
−
</tr>
 
−
<tr>
 
−
<td>&nbsp; </td>
 
−
</tr>
 
−
<tr>
 
−
<td>$0.0 - $1.0</td>
 
−
<td><br/></td>
 
−
<td >0</td>
 
−
<td><br/></td>
 
−
<td >$0</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>0.0%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$1.0 - $2.0</td>
 
−
<td><br/></td>
 
−
<td>190</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>$26</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>1.6%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$2.0 - $3.5</td>
 
−
<td><br/></td>
 
−
<td>60</td>
 
−
<td><br/></td>
 
−
<td>$190</td>
 
−
<td><br/></td>
 
−
<td>7.5%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$3.5 - $5.0</td>
 
−
<td><br/></td>
 
−
<td>40</td>
 
−
<td><br/>
 
−
</td>
 
−
<td>$449</td>
 
−
<td><br/></td>
 
−
<td>12.0%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$5.0 - $10</td>
 
−
<td><br/></td>
 
−
<td>80</td>
 
−
<td><br/></td>
 
−
<td>$1,322</td>
 
−
<td><br/></td>
 
−
<td>19.3%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$10. - $20.</td>
 
−
<td><br/></td>
 
−
<td>50</td>
 
−
<td><br/></td>
 
−
<td>$2,832</td>
 
−
<td><br/></td>
 
−
<td>22.9%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>$20. +</td>
 
−
<td><br/></td>
 
−
<td>30</td>
 
−
<td><br/></td>
 
−
<td>$23,442</td>
 
−
<td><br/></td>
 
−
<td>22.2%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
<tr>
 
−
<td>All</td>
 
−
<td><br/></td>
 
−
<td>440</td>
 
−
<td><br/></td>
 
−
<td>$2,238</td>
 
−
<td><br/></td>
 
−
<td>19.9%</td>
 
−
<td><br/></td>
 
−
</tr>
 
−
</table>
 
−
</div>The debate sometimes revolves around which estates are affected by current law.  The effects of the law on small business owners and family-owned farms (entities which, conservatives argue, are hardest hit by the estate tax) was studied in an analysis undertaken by the Tax Policy Center.  A study of the 18,800 taxable estates taxed in 2004 found 7,090 which had any farm or business income. Of those, there were 440 estates in which half or more of its assets were the value of farms and/or businesses. The effective tax rate on the 440 estates studied in detail never averaged more than 23%.
 
−
<div style="clear:both;"></div>
 
  
−
===Arguments in favor===
+
In this context equality of opportunity seems compelling. An argument can be made, however, that what is compelling about these anecdotes is the lack of opportunity of the inner-city child and not the notion of equality of opportunity.  
−
{{originalresearch}}
 
−
Proponents of the estate tax argue that it serves to prevent the perpetuation of wealth, free of tax, in wealthy families and that it is necessary to a system of [[progressive taxation]].  Proponents point out that the estate tax affects only estates of considerable size (presently, over $2 million USD, and over $4 million USD for couples) and provides numerous credits (including the unified credit) that allow a significant portion of even large estates to escape taxation.  Regarding the tax's effect on farmers, proponents counter that this criticism is misguided as there is an exemption built into the law that is specifically designed for family-owned farms.  
 
  
−
Furthermore, supporters argue that many large fortunes do not represent taxed income or savings, that wealth is not being taxed but merely the transfer of that wealth, and that many large fortunes represent unrealized capital gains which (because of a step up in [[Cost basis|basis]] at the time of death) will never be taxed as capital gains under the federal income tax.
+
Counter-argument: Let us establish equality of opportunity by ruining the schools for all. ( NOTE: Mind you only the spiteful and envious could prefer such a situation to happen when the children were unequal. )  
  
−
Proponents further argue that the estate tax serves to encourage charitable giving, one way in which individuals can avoid paying the tax.  A 2004 report by the Congressional Budget Office found that eliminating the estate tax would reduce charitable giving by 6-12 percent.
+
Yet, such must be the argument behind inheritance taxes because taxing the rich does not improve the lot of the poor. Even if the taxes raised from the rich were redistributed to the poor, instead of wasted or spent on consumption by the state, the wealth of the poor would not increase but trivially.
  
−
Another argument in favor of the estate tax relates to comparative incentives.  Proponents argue that the estate tax is a better source of revenue than the income tax, which is said to directly disincentivize work. While all taxes have this effect to a degree, some argue that the Estate Tax is less of a disincentive since it does not tax money that the earner spends, but merely that which he or she wishes to give away for non-charitable purposes.  Moreover, some argue that allowing the rich to bequeath unlimited wealth on future generations will disincentivize hard work in those future generations.  
+
The issue of opportunity must be separated from that of equality of opportunity. To increase
 +
opportunities for individuals to excel is a worthy goal but to restrict the opportunities of some in order to create “equality” among all is monstrous. Among the opportunities it is desirable to increase is the opportunity to inherit wealth.
  
−
Proponents of the estate tax tend to object to characterizations that it operates as a double or triple taxation.  They either note that such double and triple taxation is common (through income, property, and sales taxes, for instance), or argue that the estate tax should be seen as a single tax on the inheritors of large estates.
+
*2)The second reason equality of opportunity is highly regarded is that it is often favorably contrasted with equality of condition or outcome.
  
−
Supporters of the estate tax also point to longstanding historical precedent for limiting inheritance, and note that current generational transfers of wealth are greater than they have been historically.  In ancient times, funeral rites for lords and chieftains involved significant wealth expenditure on sacrifices to religious deities, feasting, and ceremonies. The well-to-do were literally buried or burned along with most of their wealth.  These traditions may have been imposed by religious edict but they served a real purpose, which was to prevent the accumulation great disparities of wealth, which tended to destabilize societies and lead to social imbalance, eventual revolution, or disruption of functioning economic systems.  This economic safety valve is now partially imposed via the estate tax, which strips excess wealth from the recently dead and diverts it back to the society as a whole.
+
Equality of opportunity, it is said, allows men to rise as far and as fast as their talents allow so long as each generation begins the race on an equal footing. Equality of outcome, by contrast, is inefficient, coercive, and totalitarian. In actuality, equality of opportunity is nothing but equality of outcome applied at the beginning of life rather than throughout life.
  
−
===The "Death Tax" neologism===
+
Both forms of equality are coercive and totalitarian.Taken seriously, equality of opportunity requires that all inheritance—monetary, genetic, and experiential—be abolished. Of the three forms, monetary inheritance is the most obvious but probably the least important creator of inequality.
−
Many opponents of the estate tax refer to it as the "death tax" in their public discourse partly because a [[death]] must occur before any [[tax]] on the deceased's [[asset]]s can be realized and also because the tax rate is determined by the value of the deceased's assets rather than the amount each inheritor receives. Neither the number of inheritors or the size of each inheritor's portion factors into the calculations for rate of the Estate Tax.
 
  
−
The term was popularized in a famous [[memorandum]] written by [[United States Republican Party|Republican]] [[opinion poll|pollster]] [[Frank Luntz]]. He recommended that the party use the term "death tax" when referring to the estate tax, writing that the term "death tax" "kindled voter resentment in a way that 'inheritance tax' and 'estate tax' do not" <ref>[http://www.60plus.org/deathtax.asp?docID=347].</ref> 
+
Genetic inheritance is the least obvious but is likely of the greatest importance with experiential
 +
inheritance (the informal education and training given by one’s parents) falling close to that of genetic inheritance. ( NOTE: It is difficult to separate these influences because they are positively correlated. )
  
−
[[Progressivism|Progressive]] [[Linguistics|linguist]] [[George Lakoff]] alleges the phrase is a deliberate and carefully calculated [[neologism|neologism]] which is used as a [[propaganda]] tactic to aid in the repeal of estate taxes.
+
As a mere beginning creating equality of opportunity would require a massive program of eugenics and the raising of children communally. Although eugenics is still a subject of taboo, yet public schools, which make the communal raising of children a partial reality, are often justified on the grounds of equality of opportunity.
  
−
===Effects of the debate===
+
The principles of equality of opportunity and equality of outcome are equally inimical to the free society. Equality of outcome, by contrast, is inefficient, coercive, and totalitarian. In actuality, equality of opportunity is nothing but equality of outcome applied at the beginning of life rather than throughout life.
  
−
Congress has passed tax laws that have changed the estate tax. Since 2003, the top rate has been lowered from 49% by one percentage point per year; in 2006 the top rate was 46%. If the US Congress makes no changes to US tax law, the top rate will continue to drop by one percentage point per year until 2009 when the top rate is scheduled to be 45%; in 2010 all estates will be taxed at 0%; and in 2011 the estate tax will return at a top rate of 55%. Most experts expect that Congress will change the tax law before then.  If the estate tax is eliminated, then unrealized capital gains would be subject to [[capital gains tax]] in order to justify the step up in basis in the hands of the new owner.
+
Taken seriously, equality of opportunity requires that all inheritance—monetary, genetic, and experiential—be abolished. Of the three forms, monetary inheritance is the most obvious but probably the least important creator of inequality.
  
−
Legislation to extend raising the unified credit (beyond year 2010) of the estate tax has passed the House of Representatives.  It also passed in the Senate in June, 2006.  Later when the [[conference committee]] added it to a bill to increase the [[minimum wage]], the combined bill failed to garner 60 votes to invoke [[cloture]] in the [[Senate]], and it failed to pass.
+
====Principle of Desert====
  
−
== IRS audits ==
+
Consider first the issue of inheritance taxes. Let us pass over the difficulties of defining “deserve” and “earn” and assume that in some sense the heir does not deserve his inheritance because he has not earned it.
−
In July 2006, the IRS confirmed that it planned to cut the jobs of 157 of the agency’s 345 estate tax lawyers, plus 17 support personnel, by October 1, 2006.  Kevin Brown, an IRS deputy commissioner, said that he had ordered the staff cuts because far fewer people were obliged to pay estate taxes than in the past.
 
  
−
Estate tax lawyers are the most productive tax law enforcement personnel at the I.R.S., according to Brown. For each hour they work, they find an average of $2,200 of taxes that people owe the government.[http://www.nytimes.com/2006/07/23/business/23tax.html?ex=1311307200&en=a1b03ade9e7403fc&ei=5090&partner=rssuserland&emc=rss]
+
How does it follow from this that the state deserves the inheritance? It is the owner of the estate who  earned it and not the government. Furthermore, if the owner of the estate earned it and thus deserves  it he must also deserve the right to allocate the estate as he wishes. Who else could deserve this  right?  Thus, even accepting that a man does not deserve what he does not earn, this is no justification for inheritance taxes.
  
−
==Related taxes==
+
The argument that desert justifies ownership is entirely misplaced. It is not a man’s duty to “justify” his claims to the state or to other men.
−
The federal government also imposes a [[gift tax]], assessed in a manner similar to the estate tax. One purpose is to prevent a person from avoiding paying estate tax by giving away all his or her assets before death.
 
  
−
There are two levels of exemption from the gift tax. First, transfers of up to (as of 2006) $12,000 per person per year are not subject to the tax. An individual can make gifts up to this amount to as many people as they wish each year, and a married couple can make gifts up to twice that amount,
+
It is the state which must justify its takings. The notion of desert as justification implicitly regards ownership as a gift granted by the state and given only so long as a man can “justify” such ownership to the state’s inquisitors.
  
 +
Yet it is the inquisitors who must be questioned. The state justifies its existence only to the extent that it protects the rights of individuals. This is the meaning of the “Declaration of Independence” when it declares that:
  
−
==Notes==
+
”…… every man has, certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness….That, to secure these Rights, Governments are instituted among Men, deriving their just Powers from the Consent of the Governed, that whenever any Form of Government becomes destructive of these Ends, it is the Right of the People to alter or to abolish it……”
−
<references/>
+
 
 +
==Conclusion==
 +
 
 +
So long as men are mortal, wealth should be --- for several reasons; among them: long-term capital projects, efficiency of capital investment --- transferred between the generations and so long as
 +
parents care for their children the dominant means of doing so will be through family inheritance.
 +
 
 +
The transference of wealth through the family benefits bequestor and heir, strengthens family ties, and increases long-term savings. When the state intervenes in this process it increase its coffers at the expense of the smooth operation of family, society, and economy.
 +
 
 +
Even if a given amount of taxes must be raised  it is probably preferable to tax consumption rather
 +
than to tax capital accumulation because private savings are the basis of economic growth. The estate
 +
tax is among the worst taxes on these grounds, as  Rothbard (1970, p. 113) notes:
 +
 
 +
“……'''''The inheritance tax is perhaps the most devastating example of a tax on pure capital'''''…...”
  
 
==References==
 
==References==
  
−
* Ian Shapiro and Michael J. Graetz, ''Death By A Thousand Cuts: The Fight Over Taxing Inherited Wealth'', Princeton University Press (February, 2005), hardcover, 372 pages, ISBN 0-691-12293-8
+
*Buchanan, J., Cost and Choice, Markham, Chicago, 1969
−
*William H. Gates, Sr. and Chuck Collins, with foreword by former Federal Reserve Chairman Paul Volcker, ''Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes'', Beacon Press (2003)
+
*Fetter, Frank A., The Principles of Economics, Century New York,  1913
 +
*Groves, Harold. M., Financing Government, Henry Holt, New York: 1939
 +
*Kotlikoff, L., and L. Summers, “The Role of Intergenerational Transfers in Aggregate
 +
Capital Accumulation,“ Journal of Political Economy , vol. 89, 1981, pp. 706-732
 +
*Lawrence, M. and Carl Davidson,. "Tax incidence in a simple general equilibrium model with collusion and entry," Journal of Public Economics, vol. 45(2), Elsevier, 1991, pp. 161-190
 +
*Read, H.E., The Abolition of Inheritance, MacMillan, New York, 1918
 +
*Ricardo, D.,  Principles of Political Economy and Taxation,  Dent, London, 1817, chap. 8 ( for his comments on transfer taxes and savings )
 +
*Rothbard, M., “ Towards the Reconstruction of Utility and Welfare Economics”; in: On Friedom and Free Enterprises  ( ed. Mary Sonnholtz ) , Van Nostrand, Princeton, 1956
 +
*Rothbard, M., Nan, Economy and State, vols, 1 and 2. , Nash Publ. , Los Angeles, 1970
 +
*Schumpeter, Joseph A.. Capitalism, Socialism and Democracy, Harper and Row, New York, 1942
 +
*Smith Adam, The Wealth of Nations, Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition, Book 5, chap. 2, pt. i, appendix to articles 1 and 2
 +
*Tabarrok, A.” Death Taxes: Theory, History, and Ethics” in: Essays in Political Economy, Ludwig von Mises Institute (Auburn University, Auburn, AL ) USA, 1997;  translated into Spanish as Impuestos a la herencia: teoría, historia y ética (Eseade, 2002)  
 +
*Taussig, F.W., Principles of Economics, Vol, 2, Macmillan, New York, 1920
 +
*von Mises, L., Socialism, Indianopolis 1934; Liberty Classics 1981
 +
*Wagner, R., Inheritance and State, American Enterprise Institute, Washington, 1977
 +
 
 +
 
 +
 
  
 
==External links==
 
==External links==

Revision as of 19:50, 11 September 2007


Inheritance tax, estate tax and death duty are the names given to various taxes which arise on the death of an individual. Technically, the inheritance tax and the estate tax are different although we shall use the terms interchangeably, except where the distinction is important; in the UK, an inheritance tax would be equivalent to an estate tax.

In the U.S. an estate tax is paid out of the deceased’s estate before it is distributed. The same total tax is paid, therefore, whether there is one heir or dozens and the same tax is paid whether the heirs are rich or poor.

Brief overview of the Inheritance and/or Estate Tax

Some basic definitions

Depending on where you live the tax code may make reference to "inheritance tax", "estate tax" and even "death duty."

In the United States, there is a difference between estate taxes and inheritance taxes. Estate taxes are levied on representatives of the deceased person, while inheritance taxes are levied on the beneficiaries of an estate.

Elsewhere in the world, the terms estate tax and inheritance tax are used interchangeably.


An "inheritance tax" is paid by the heir and may vary according to the heir’s relation to the deceased, the heir’s income and wealth, and the amount inherited. If an inheritance tax is, in any of the senses above, progressive then the total tax paid will vary according to the number of heirs and their wealth.


The “estate tax” is a tax on net worth, the value of all property owned minus debt and any estate expenses. Essentially the tax is an “everything tax.” It’s a tax on cash and bank accounts, stocks, bonds, real estate, businesses, equipment and machinery, automobiles and other property, life insurance policies, artwork, even personal belongings.


In, both, the U.S. and Great Britain, egalitarians tend to prefer an inheritance tax since this gives the deceased an incentive to spread wealth across many heirs ( John Stuart Mill proposed an inheritance tax, for example) while pragmatists tend to support the estate tax because it is easier to administer and will tend to raise more revenue than the inheritance tax (precisely because it cannot be avoided by increasing the number of heirs).

Calculation of Inheritance Tax in the U.S.

  • Inheritance Tax Basis:

The first step used to determine any inheritance tax that might be due is to calculate the fair market value of the entire estate. This would include cash, bank accounts, stocks and bonds, real state, insurance and similar items of value. The total fair market value of all these items is termed the Gross Estate.


  • Adjustments to Gross Estate:

The next step would be to calculate any adjustments to the gross estate. Typical adjustments include the remaining balance on a mortgage or the fees associated with settling the estate. This last item might include items such as estate administration fees or payments made to an attorney. Finally, there is also a Marital Deduction that can be taken for property that is left to a surviving spouse.


  • Net Value of Property:

Once all the deductions have been taken from the gross estate, the remaining balance is considered the net value of the property - or the inheritance tax basis.

To calculate whether nor not any inheritance tax is due; the net value of the property must be subtracted from the inheritance tax credits appearing in the tables below. If the net estate is larger than the tax exclusion, then the federal income taxes due can be found on the standard tax brackets or tax rate tables published by the IRS.


  • Taxing of Life Insurance Proceeds:

Life insurance proceeds paid to you are used in the calculation of the gross estate. The value of any insurance received is subject to the unified credits and inheritance tax exemptions explained later. This last statement is true if you elect to receive the proceeds in the form of a single lump sum.

If you elect to receive life insurance proceeds in installments, then you need to separate the value of the insurance inherited from the total of all payments to determine your federal tax liability.

For example, you may be able to elect to receive a lump sum of $100,000 or $10,000 per month for 12 months. The difference between the lump sum payment and the money received is due to interest you are earning on the policy by taking installments.

In this example, you are receiving a total of 12 x $10,000 or $120,000, which is $20,000 higher than the lump sum of $100,000. This means that you would need to pay income tax on the $20,000 received in the form of interest income.


  • Unified Credits, Gift Tax and Estate Tax:

The Unified Credit is used to eliminate or reduce your tax liability. The credit applies to both gifts you may have received and estates that have been inherited. The credit is termed a lifetime credit because as it is consumed by each gift or estate inherited the credit is reduced. The lifetime credit applies to all inheritance or gifts received since 1977.

The lifetime gift tax exclusion you can take in 2006 is $1,000,000. Another way of looking at the same information is to state that you have a $345,000 tax credit that you can apply to any income taxes owed on gifts.


Rising problems with Inheritance tax in OECD

"Inheritance tax" used to make the news only when it forced once super-rich dynasties to flog their heirlooms after the head of the family died. But suddenly, death is getting expensive for a much larger number of Europeans, and that's starting to attract the attention of politicians and headline writers across the Continent.

Furious discussions about whether to limit, amend or suppressinheritance taxes broke out last week in both Britain and France.

In Italy, meanwhile, there's controversy and skepticism about plans by the new government[an error occurred while processing this directive] of Romano Prodi to reinstate the inheritance tax abolished by former Prime Minister Silvio Berlusconi in one of his first acts on taking office in 2001.

The debate is erupting now because death duties of up to 40%, once paid only by the affluent, are starting to affect a growing number of middle-class Europeans — and will likely hit millions more in the decade to come.


"……Inheritance tax used to be a problem for the rich. Now it's a problem for you and me….." says Anne Young, a tax expert at the Edinburgh financial-services firm Scottish Widows, who calculates that about 1 in 3 of Britain's 24 million households now have estates that would fall within the taxman's reach. Young herself admits she has an inheritance-tax "problem."


Blame the explosion of house prices. Unlike their parents, European baby boomers tend to own their homes. As prices have soared over the past few years in almost every country except Germany, these homeowners have enjoyed big increases in the value of their total assets. But in many cases, the rise has pushed their net worth over the national minimum thresholds for inheritance tax, which haven't been adjusted in step with the housing boom. The result: almost anyone owning a detached house in London or southeast England is already well over the U.K. tax-free limit on estates of $540,000.


France is even tougher. There, inheritance tax is levied in theory from the first euro passed on, but a series of tax-free thresholds apply to family members, including a €50,000 one for children of the deceased. The value of even a modest two-bedroom apartment in central Paris is enough to push families into a 30% tax bracket (the top rate for them is 40%, for estates valued at over €1.7 million).

For nonfamily members and unmarried partners, the situation is even more complicated, with inheritance tax rising as high as 60%. And unlike many other countries, where the tax is levied when assets are handed down a generation, husbands and wives in France are subject to death duties on what they inherit from their spouses.


In the U.S., the subsequent administrations to Ronald Reagan's one have left the following legacy concerning the Inheritance Tax:


  • The rate was scheduled to fall to 50 percent by 1993, however, ERTA ( i.e. Economic Recovery Act of 1981 ) had scheduled the rate to fall to 50 percent by 1985, but this reduction has been twice delayed and pushed off to the farther future; the general public may never see the 50 percent rate promised in ERTA.
  • Marginal rates begin at 37 percent after the first $600,000.
  • There is a peculiar non-linearity in the schedules so that the tax rises to 60 percent between $10,000,000 and $21,040,000 but then falls to 55 percent again. It’s unclear why this non-linearity exists.

Economics of minimal Inheritance Taxes

Before we enter this domain, a few excerpts should precede it:

“…..This does not imply that once-earned wealth perpetuates itself forever. On the contrary, even if a fortune were completely immune from risk it would tend to quickly dissipate so long as there is more than one heir in each generation. In a free market wealth is continually changing hands…… .….Increasing and even maintaining a fortune requires entrepreneurial skill……” ( von Mises 1981, pp. 338–40 ).

“…….Consider how much easier it is to waste a million dollars than it is to make a million dollars. Nevertheless, wealth will typically last more than one generation so it is reasonable to argue that at least two generations of heirs are significantly harmed by the estate tax……( ibid.).

“…In modern times the funds raised by the estate and gift tax have accounted for only a small proportion of government revenue…In 1990 death and gift taxes raised just over $15 billion in revenue, approximately $11 billion of which was because of the Federal estate and gift tax the remainder because of state death and gift taxes; as seen in Statistical Abstract of the United States, 1990…” ( Tabarrok, 1997) .

Inter-generation transfers and “working” capital accumulation

In spite of the best efforts of social engineers, the estate tax has not had a revolutionary effect on aggregate income inequality, although some families have been devastated by the tax. In fact, both, Adam Smith and David Ricardo ( Smith, 1904 ; Ricardo, 1917) argued that the inheritance tax reduced savings, and, in causal relation, future capital investments.

Since the 1950s, however, the dominant opinion among economists has been that the bequest motive has little to do with saving and capital accumulation. So even if true, the slight sapping of savings by estate taxation was not to be worried about. Recent work, however, challenges the dominant view of savings ( see Kotlikoff and Summers, 1981) .

Strictly speaking, however, the modern bequest theory is an inter-generational transfer theory of saving. Hence, a tax on the transfer of property between the generations can affect savings by changing the behavior of the bequestor or the heir. The effect on the bequestor is composed of two parts:

  • the price effect and
  • the wealth effect.

The tax raises the price of bequests and therefore reduces the desired bequest. The effect on savings, however, is ambiguous.

Imagine that a man wishes to bequeath an estate of $1 million to his daughter. If there is no tax he must save $1 million, but if there is a tax of 50 percent and he still wishes to bequeath $1 million he must increase his savings to $2 million.

In most circumstances the bequestor will want to reduce the amount of bequest, but so long as the reduction in final bequest is less than 50 percent the price effect works to increase saving. The price effect can be summarized in terms of elasticities. If the demand to give bequests is inelastic the price effect works to increase savings.

Little data exist on this elasticity but a demand curve must be elastic above some price, otherwise a consumer could be made to spend all of his income on the single taxed good ( Wagner 1977, p. 19 ). At today’s rates of 55 percent the demand for bequests is probably elastic and there is little doubt that if the rates were raised by any significant degree the amount of savings would be reduced.

Reinforcing the reduced savings because of the price effect is the wealth effect. For a given size of bequest, an increase in the estate tax is equivalent to a reduction in wealth. The desire to give bequests decreases (increases) as wealth decreases (increases). In other words, bequests are a “normal” good.

The effect of estate taxation on the heir’s savings decision is important although rarely discussed even though it formed the focus of Ricardo’s comments ( Ricardo, 1917 ) .

An inheritance is a large, one-time, increase in wealth. Income smoothing requires that the bulk of this wealth be saved. A decrease in the heir’s inheritance is therefore ipso facto, a large decrease in savings.

Indeed, if the bequestor and heir have similar wealth and value scales, the heir will want to save the principal portion of the estate so that it can be passed on to his own heirs. This is what accounts for the fact that family fortunes are typically the accumulated savings of more than one generation.

Bequest-saving tends to be long-term and continuous and therefore allows for what F.W. Taussig called “…sustained accumulation and permanent investment…..” ( Taussig, 1920, p. 249) .This is especially true when savings are passed along in the form of family businesses.

Questions of morality and efficiency of inheritance

Those who are able to bequeath a material inheritance are also often able to bequeath a sound moral and educational inheritance. Along with pecuniary and physical capital the founding generation bequeaths human capital. In a capitalist society, therefore, the institution of inheritance is more than a moral institution, it is part of the process whereby wealth is transferred to those who can best use it to serve the wishes of consumers.

Consider the following three proposals and let us try to assess which will cause the most efficient distribution of wealth according to the wishes of consumers:

  • (1) Inheritance according to the will of the owner,
  • (2) Inheritance to a randomly picked individual, or
  • (3) The state takes the inheritance as tax revenue ( see Rothbard, 1970 in the below note ) ?

In the long run only the market can reveal who possesses the entrepreneurial spark. But when wealth must be passed from one generation to another the institution of inheritance seems to be both moral and efficient.


Problems in government investing of the inheritance tax

One reason most neo-classical economists ignore the effect of the estate tax on the heir’s saving is the argument that the government can also “save” the estate tax by investing it in capital projects.

From that does not immediately follows that if the bequestor reduces his savings in the face of the estate tax, savings must decline regardless of what the government does with the tax revenue. At best, this objection, even if accepted, blunts but does not overturn the negative effect on savings derived from the behavior of bequestors. 


But, generally, there are several flaws with this argument:
  • First, the wealthy tend to have low rates of time preference which allows family fortunes to be

invested in long-term projects see the above Taussig’s “sustained accumulation and permanent investment” ( Lawrence, 1991) . Even assuming that governments were to “invest” the proceeds of the tax rather than spend it on redistribution and pork barrel projects, governments are dominated by politicians whose time horizons are measured in years to the next election rather than in decades and generations.

  • Second, and more fundamentally, there is a crucial difference between government investment

and private sector investment. Only in the latter case can it be concluded that investments are welfare-enhancing ( Rothbard 1956 ). Private sector savings are necessarily allocated to maximize consumer and producer well-being. Government savings are allocated according to arbitrary political fiat. Rothbard (1970) has made a strong case that so called government investment is better understood as consumption by government officials rather than savings.

Adam Smith’s distinction between unproductive and productive labor was never more apt than when he wrote:

“…..All taxes upon the transference of property . . . are all more or less unthrifty taxes that increase the revenue of the sovereign, which seldom maintains any but unproductive laborers; at the expense of the capital of the people, which maintains none but productive….”( Smith, 1904 ).

To evaluate the effect of higher estate ( or inheritance ) taxes, it is therefore necessary to examine the life cycle theory ( see the next paragraph ). Traditionally, many economists believed that the most important reason people saved was to give bequests. Alfred Marshall (1949, p. 227) held that “….family affection is the main motive for saving…..”

Schumpeter (1942, p. 160) called the “….family motive” the “mainspring” of savings…..”, and F.W. Taussig (1920, p. 249) argued that for long-term savings “…..the main motives are domestic affection and family ambition…….”

Elsewhere Taussig (1920, p. 509) called inheritance “……the great engine for the maintenance of capital……” and, in his highly regarded principles text, Frank A. Fetter (1913, p. 371) argued that “…….Much of the existing wealth probably never would have been created if men did not have [the] right of gift…...”

In fact, the entire capitalist order for Schumpeter (1942, p.160 and passim) is founded on the family motive. “…….When the capitalist-entrepreneur-bourgeois is sundered from longterm family ties he becomes, to borrow a phrase, a wage slave or bureaucrat-cog easily crushed by the state and its philosophical apparatus……..” ( ibid. ).

Cycle Theory of Saving

The theory of saving was the central component of post World War II Keynesian macroeconomics but the bequest theory was completely abandoned during this period. In its place was put the life cycle theory of saving because of Modigliani and Brumberg (1954) . The life cycle theory places the main motivation for saving on the desire to provide for retirement. The theory implies that savings should follow a “hump” pattern.

Young adults begin the saving process by borrowing; as their career stabilizes they pay off old debts and begin to save, then, when retirement begins, they draw down their savings until they die. In the simple model, everyone wishes to consume up to the moment of death and then die penniless. In more complicated models a bequest motive is tacked on as an afterthought.

Yet, far before the life cycle theory was born, Alfred Marshall ( 1949, p. 228) recognized an important fact which casts doubt on the theory. He noted that “…. men seldom spend, after they have retired from work, more than the income that comes in from their savings, preferring to leave their stored up wealth intact for their families……..” ( ibid. )

In other words, the elderly do not dissave as the life cycle theory predicts. Marshall’s observation has been verified by a number of studies in recent years.36) Far from dying penniless, the elderly often die richer than at any other point in their life. A related point is the low demand among the elderly for annuities and reverse mortgages. Some economists have claimed that uncertainty about time of death explains why the elderly do not dissave.

But if this were the motivation for maintaining income in old age we would expect the elderly to invest in annuities and reverse mortgages. An annuity is like life insurance in reverse. A large and certain payment is made today in return for an income stream which lasts until death. Similarly, in a reverse mortgage the buyer promises to will his house to a firm in return for an income stream which is paid until death.

If they wanted to do so, the elderly could use these devices to consume their wealth without fear of being destitute in the event that they live longer than expected. The fact that these markets are relatively small suggests that the main reason the elderly do not dissave is to make bequests. Instead of buying annuities, which the life cycle theory predicts, many elderly persons are trying to get rid of annuities the government has forced them to buy.

One of those annuities is Social Security that taxes income in early periods and then returns that income in later periods in annuitized form. Social Security changes not only the amount of saving but the type of saving which occurs—it favors annuity saving rather than saving in the form of bequestable wealth.

Imagine that a man has paid $100,000 into Social Security. After he retires, this money begins to return to him in periodic payments. If he lives long enough he may even see the entire $100,000 again, but if he dies after consuming only half of his $100,000 payment he cannot bequest the remaining $50,000.

In addition to these theoretical arguments, recent econometric work by Kotlikoff and Summers (1981) indicates that the stock of wealth is far too large to be accounted for by life cycle reasons. Although hotly debated and challenged, the bequest wealth is now recognized to be much more important than previously thought.

Hence, the theoretical and empirical shortcomings of the life cycle theory indicate that the bequest motive is an important determinant of savings. This means that far from being negligible the estate tax and gift tax could significantly reduce total savings. If the current exemption were to be lowered the increase in the estate tax base would be considerable and savings could be even more adversely affected.

Ethical Justifications of Inheritance Tax

=Equality of Opportunity

Economists and other writers often ethically rationalize the estate and inheritance taxes by appealing to the principle of equality of opportunity. Economist and Nobel Prize winner James Buchanan, for example, argue that”…… a guarantee of “some” equality of opportunity is inherent in the political philosophy of the free society…….” ( Buchanan, 1975, p. 303 )

And Groves (1939, p. 248) correctly notes that equality of opportunity is often accepted as desirable “by the most ‘rugged’ of individualists.”

Closely linked with the idea of equality of opportunity is the principle of desert. Many who reject as morally repugnant confiscatory income taxes accept the inheritance tax because the individual does not “earn” his inheritance and is therefore undeserving. Harlan Read (1918, p. 279) stated the thesis boldly in his Abolition of Inheritance: “…….All estates are unearned by the heirs and should therefore, be taken by taxation……..”


From the correct idea that a man deserves what he earns he draws the incorrect conclusion that a man does not deserve what he does not earn.

The principle of equality of opportunity and the principle of desert are both inimical to the free society. There are, however, at least two uncertainties in these moral principles:

  • 1)Stated in a certain fashion it appears inherently just and when contrasted with equality of condition or outcome it appears manifestly superior. Equality of opportunity is often presented in the context of lack of opportunity.

Typical argument: The intelligent child of the inner city who is unable to excel because he lacks a good education is contrasted with the luckier child of the suburb. Why should forces for which the child is not responsible and does not control be such a large factor in his life? Why are otherwise identical individuals placed in such differing circumstances?

In this context equality of opportunity seems compelling. An argument can be made, however, that what is compelling about these anecdotes is the lack of opportunity of the inner-city child and not the notion of equality of opportunity.

Counter-argument: Let us establish equality of opportunity by ruining the schools for all. ( NOTE: Mind you only the spiteful and envious could prefer such a situation to happen when the children were unequal. )

Yet, such must be the argument behind inheritance taxes because taxing the rich does not improve the lot of the poor. Even if the taxes raised from the rich were redistributed to the poor, instead of wasted or spent on consumption by the state, the wealth of the poor would not increase but trivially.

The issue of opportunity must be separated from that of equality of opportunity. To increase opportunities for individuals to excel is a worthy goal but to restrict the opportunities of some in order to create “equality” among all is monstrous. Among the opportunities it is desirable to increase is the opportunity to inherit wealth.

  • 2)The second reason equality of opportunity is highly regarded is that it is often favorably contrasted with equality of condition or outcome.

Equality of opportunity, it is said, allows men to rise as far and as fast as their talents allow so long as each generation begins the race on an equal footing. Equality of outcome, by contrast, is inefficient, coercive, and totalitarian. In actuality, equality of opportunity is nothing but equality of outcome applied at the beginning of life rather than throughout life.

Both forms of equality are coercive and totalitarian.Taken seriously, equality of opportunity requires that all inheritance—monetary, genetic, and experiential—be abolished. Of the three forms, monetary inheritance is the most obvious but probably the least important creator of inequality.

Genetic inheritance is the least obvious but is likely of the greatest importance with experiential inheritance (the informal education and training given by one’s parents) falling close to that of genetic inheritance. ( NOTE: It is difficult to separate these influences because they are positively correlated. )

As a mere beginning creating equality of opportunity would require a massive program of eugenics and the raising of children communally. Although eugenics is still a subject of taboo, yet public schools, which make the communal raising of children a partial reality, are often justified on the grounds of equality of opportunity.

The principles of equality of opportunity and equality of outcome are equally inimical to the free society. Equality of outcome, by contrast, is inefficient, coercive, and totalitarian. In actuality, equality of opportunity is nothing but equality of outcome applied at the beginning of life rather than throughout life.

Taken seriously, equality of opportunity requires that all inheritance—monetary, genetic, and experiential—be abolished. Of the three forms, monetary inheritance is the most obvious but probably the least important creator of inequality.

Principle of Desert

Consider first the issue of inheritance taxes. Let us pass over the difficulties of defining “deserve” and “earn” and assume that in some sense the heir does not deserve his inheritance because he has not earned it.

How does it follow from this that the state deserves the inheritance? It is the owner of the estate who earned it and not the government. Furthermore, if the owner of the estate earned it and thus deserves it he must also deserve the right to allocate the estate as he wishes. Who else could deserve this right? Thus, even accepting that a man does not deserve what he does not earn, this is no justification for inheritance taxes.

The argument that desert justifies ownership is entirely misplaced. It is not a man’s duty to “justify” his claims to the state or to other men.

It is the state which must justify its takings. The notion of desert as justification implicitly regards ownership as a gift granted by the state and given only so long as a man can “justify” such ownership to the state’s inquisitors.

Yet it is the inquisitors who must be questioned. The state justifies its existence only to the extent that it protects the rights of individuals. This is the meaning of the “Declaration of Independence” when it declares that:

”…… every man has, certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness….That, to secure these Rights, Governments are instituted among Men, deriving their just Powers from the Consent of the Governed, that whenever any Form of Government becomes destructive of these Ends, it is the Right of the People to alter or to abolish it……”

Conclusion

So long as men are mortal, wealth should be --- for several reasons; among them: long-term capital projects, efficiency of capital investment --- transferred between the generations and so long as parents care for their children the dominant means of doing so will be through family inheritance.

The transference of wealth through the family benefits bequestor and heir, strengthens family ties, and increases long-term savings. When the state intervenes in this process it increase its coffers at the expense of the smooth operation of family, society, and economy.

Even if a given amount of taxes must be raised it is probably preferable to tax consumption rather than to tax capital accumulation because private savings are the basis of economic growth. The estate tax is among the worst taxes on these grounds, as Rothbard (1970, p. 113) notes:

“……The inheritance tax is perhaps the most devastating example of a tax on pure capital…...”

References
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  • Buchanan, J., Cost and Choice, Markham, Chicago, 1969
  • Fetter, Frank A., The Principles of Economics, Century New York, 1913
  • Groves, Harold. M., Financing Government, Henry Holt, New York: 1939
  • Kotlikoff, L., and L. Summers, “The Role of Intergenerational Transfers in Aggregate

Capital Accumulation,“ Journal of Political Economy , vol. 89, 1981, pp. 706-732

  • Lawrence, M. and Carl Davidson,. "Tax incidence in a simple general equilibrium model with collusion and entry," Journal of Public Economics, vol. 45(2), Elsevier, 1991, pp. 161-190
  • Read, H.E., The Abolition of Inheritance, MacMillan, New York, 1918
  • Ricardo, D., Principles of Political Economy and Taxation, Dent, London, 1817, chap. 8 ( for his comments on transfer taxes and savings )
  • Rothbard, M., “ Towards the Reconstruction of Utility and Welfare Economics”; in: On Friedom and Free Enterprises ( ed. Mary Sonnholtz ) , Van Nostrand, Princeton, 1956
  • Rothbard, M., Nan, Economy and State, vols, 1 and 2. , Nash Publ. , Los Angeles, 1970
  • Schumpeter, Joseph A.. Capitalism, Socialism and Democracy, Harper and Row, New York, 1942
  • Smith Adam, The Wealth of Nations, Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition, Book 5, chap. 2, pt. i, appendix to articles 1 and 2
  • Tabarrok, A.” Death Taxes: Theory, History, and Ethics” in: Essays in Political Economy, Ludwig von Mises Institute (Auburn University, Auburn, AL ) USA, 1997; translated into Spanish as Impuestos a la herencia: teoría, historia y ética (Eseade, 2002)
  • Taussig, F.W., Principles of Economics, Vol, 2, Macmillan, New York, 1920
  • von Mises, L., Socialism, Indianopolis 1934; Liberty Classics 1981
  • Wagner, R., Inheritance and State, American Enterprise Institute, Washington, 1977


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