What components must a tax and budget management system have to achieve the results we want? I’ll start with a result and a candidate that illustrate a few large issues.
It seems to me now that what I said was my biggest surprise in this post, Qualities of an Excellent Tax System, should not have been a surprise at all. The American Dream is that our freedom includes equal opportunities for all of us to achieve prosperity and success. In that case, it makes sense that nine out of ten of us would say we want a relatively equal distribution of wealth. What we mean is, we want relatively equal opportunities to become wealthy.
So, the system needs to to, “lead toward the distribution of wealth we democratically choose”. By “lead toward” I mean propel the wealth distribution on average and over time, and by “democratically choose” I mean the distribution we want could change but it should at all times be in some way explicitly approved by the electorate.
Among the indicated requirements is to diminish, “unfair opportunity based on parental wealth”. Estate taxes are a potential mechanism. How much support might there be for them, and how effectively would they support the objective?
Estate taxes would not be popular at all. The compendium of public opinion research I used for this post about our tax system shows on page 21 the results of a March 2009 Harris poll about the perceived fairness of various kinds of federal and state/local taxes. Federal estate taxes are considered the least fair of all. Two in five respondents (42%) consider them “not at all fair”. Fully two thirds (67%) consider them “somewhat or not at all fair”.
Before exploring if estate taxes could nevertheless be effective, it’s instructive to set their unpopularity in context. Every form of tax has high “somewhat or not at all fair” ratings.
At the federal level, the combined “somewhat or not at all fair” ratings for each type of tax are: estate taxes 67%, gas taxes 63%, personal income taxes 48%, corporate income taxes 42%, social security payroll taxes 40%, and cigarette, beer and wine taxes 36%. At the state/local level they are: gas taxes 62%, local property taxes 50%, motor vehicle taxes 47%, state income taxes 44%, cigarette, beer and wine taxes 38%, and retail sales taxes 37%.
I’ll come back to those statistics in future posts. One thing to consider is the seeming paradox that while gas taxes are almost as unpopular as estate taxes, retail sales taxes, which are also levied at point of sale and unlike gas taxes are shown separately and so are more visible, are considered the least unfair of taxes along with those on cigarettes, beer and wine. I’ll also address why property and motor vehicle taxes, personal and corporate income taxes, and social security payroll taxes are all considered “somewhat or not at all fair” by 40% to 50% of us. The overall message from these statistics is:
Large issue 1: While everyone wants government services, many or most of us consider every way of funding them to be “somewhat or not at all fair”. It will not be enough to establish a way of collecting revenue that is reasonably fair. We must also routinely measure its fairness, publish the results and measure public opinion about that. The long term result, if the system truly is fair, will be a steep bell curve of survey results toward the middle of the range from “Very fair” to “Not at all fair”. I’ll explore this in a future post.
Meanwhile, why are estate taxes considered most unfair of all? Because they’re associated with death. That’s why opponents call them the “death tax”. We’re pretty much terrified of death and we don’t like any taxes, anyway. Also, opponents tell us it’s double taxation: “First, they took your hard-earned money in income tax, then they want estate taxes on what’s left?!” And while in theory we want equal opportunity for all to become wealthy, we probably in reality want our kids to have a better than equal chance. The message from this statistic is:
Large issue 2: We are vulnerable to powerful fears and desires that distort our judgment about government and taxes which cannot be soothed from within the tax system. We would be happier and kinder if we accepted that we will die. It would be better to prepare our kids to work for what they most want. The tax system is powerless to help us accept and act upon such truths.
Would estate taxes nonetheless be an effective way to diminish the unfair advantage of parental wealth? The answer is again, in normal circumstances, no. Estate taxes are in reality levied on only a tiny fraction of US estates and they are easy to avoid altogether with trusts and provisions in your will. If, that is, you act on the fact that you will die.
More importantly, revenue from estate taxes fluctuates because people with equal wealth do not die at the same rate every year. That means estate taxes are unsuitable for supporting ongoing levels of spending. There is also:
Large issue 3: Wealthy people can relocate their assets. Not all US states levy estate or inheritance taxes and those that do, have different rates and thresholds. You can become a resident of a different state if you expect to leave or inherit a large estate. The same issue exists for state income taxes as this link suggests. And if you want to avoid US taxes altogether, you can renounce your citizenship and move offshore. This means tax systems must be appropriate to their competitive environment, state-wise and nation-wise.
There are, however, a couple of situations where estate taxes are effective. One is when there is a widely accepted temporary need for exceptionally high government spending. By the end of WW2, for example, the top marginal estate-tax rate, referred to as “equality of sacrifice”, was 75% in the UK and 77% in the US. In WW1 when UK men were being conscripted, very high estate taxes were termed “conscription of wealth”. The other situation is when the domination of a wealthy hereditary aristocracy is overturned. The sacrifice made necessary by WW1 gave UK social reformers that opportunity.
We should work diligently and hard to avoid the need and opportunity for such a remedy in our own society.
JohnK commented: “I would add that, while the best argument against this tax is the double-taxation argument, another purported problem is that some small family-owned farms and businesses might have to be liquidated to pay estate taxes when the progenitor dies leaving the children to find some other line of work.”
There is a good analysis of “purported problems” created by estate taxes at:
http://www.cbpp.org/files/estatetaxmyths.pdf
The claim that estate taxes force liquidation of small family-owned farms and businesses is bogus. Only 20, repeat twenty, small businesses and farm estates will owe any estate tax at all in 2013. If any of the twenty face liquidity constraints, they can spread estate tax payments over 15 years at low interest rates.
The double-taxation argument is also bogus. Much of the money in the 3,780 estates (fewer than 2 in 1,000 of all estates) that do owe estate taxes was never taxed. It is the increase in value of assets that would only have been taxed (as a capital gain) if the deceased individual had sold the assets. The estate tax was established in 1916 exactly because this form of income would not otherwise be subject to tax.
Another often-made claim is that whether or not the estate tax is “fair” or has undesirable side-effects, it produces too little revenue to be worth collecting. That also is bogus. Estate tax revenue is projected to total $200B+ over the next ten years, which is enough to fund the FDA, Centers for Disease Control and Prevention and the EPA.
These powerful but spurious claims use our fear of death and unfairness to cause most of us to oppose estate taxes even though only a tiny fraction of us will owe any. Estate taxes provide significant government funding by taxing income that would not otherwise be taxed but they need to be overhauled in an increasingly global economy and because our current system makes them easy to avoid.
Liberal economists (i.e., those who don’t believe that taxes are inherently immoral) argue that estate taxes are the most economically efficient, they do not have the downsides associated with, for instance, high marginal rates. The fact that we now call estate taxes “death” taxes owes more to a brilliant conservative propaganda offensive than a ground swell in popular opinion. Estate taxes are just too important to concede to the Right. Middle class owners of small business, farms, etc, could probably be “bought off” in this debate with a tax threshold (which already exists) and further tweaks. I think what is more relevant is that there was very little push back on this issue (iirc [admin = “if I remember correctly”], is Clinton era vintage)
Please say more about: “estate taxes are the most economically efficient” and/or point to a discussion of the theory. I think I know what this means, but it’s all too likely I don’t, and it sounds like an important point.
I am not sure I remember the complete discussion I read in Bob Kuttner’s “The Economic Illusion” but basically the idea is that the mainstream economic argument about high marginal taxes is that they are (or can be) a disincentive. A successful entrepreneur or inventor would be dissuaded from the next innovation or the next gadget because the return on the income diminishes with the higher marginal rate. So basically the reason estate taxes are efficient is that there is no marginal disincentive (or a very small one).
Similarly, there is the idea in economics that market incentives result in optimal outputs through price and market competition. I.e., capitalism encourages the creation of new wealth. But those who merely are seeking rents (attempting to increase their income by acquiring an asset through means other than productive economic activity) are basically parasitical. Changing inheritance laws to pay less tax, or, more generally, just waiting around for the older generation to die and collect inheritance is classic “rent-seeking”. Inheritance bears little or no relation to what makes capitalism productive. Or so the argument goes.
(By the way, Kuttner is a good progressive journalist with a master’s in economics. I find him very informative on any topic he writes on.)
And just to be clear, this is a relative distinction. I.e. there are reasons to be suspicious of just how much of a disincentive high marginal rates are or whether, assuming that such a disincentive is significant, said disincentive has an impact on overall productivity. But the point is, when conservatives criticize taxes on the ground of economic efficiency, estate taxes are the last ones that should concern them.
Yes, I plan to start exploring the extent to which taxes create disincentives and impact overall economic growth and productivity when I get to income taxes.