Why the Estate Tax?

Of the 3 major types of income that are taxed — working income, investment income, and inherited income — inherited income is taxed the least, benefits mostly the wealthy, and takes no effort to receive it. Indeed, the wealthy receive most of the investment income as well, and that, too, is taxed less than working income. Unlike gift and estate taxes, there is no exemption amount for working income.

No doubt the reason for this state of affairs is that the wealthy donated a lot of money to members of Congress, especially to the Republican Party. Indeed, a tax law passed on December 17, 2010 allows hedge fund managers, some who make hundreds of millions dollars per year, to be exempt from income and payroll taxes, allowing them to pay only the capital gains tax which, then, had a top rate of 15% — this is slightly more than the payroll tax paid by self-employed people making less than the social security wage base limit (2023: $160,200) per year. Indeed, this is a lower tax rate than a self-employed individual must pay on an income of a mere $20,000!

Republicans continually try to eliminate the estate tax permanently, even though the United States has a significant deficit and a federal debt that now exceeds the largest debt ever incurred. Both President George Bush, and, more recently, Donald J Trump have greatly increase the federal debt so that they can give tax breaks to the wealthy. Obama also increased the debt, but he did so to stimulate the anemic economy after the 2007-2009 Great Recession, and to provide affordable healthcare for those who could not afford it. So what are the arguments for and against the estate tax?

Arguments for an Estate Tax

It creates a fairer tax system. After all, why should working people have to pay a substantial amount of their income as taxes while others, mostly wealthy, can receive their inheritance tax-free?

A fundament of economics is that higher prices for buyers reduces demand and lower prices for suppliers reduces supply. Taxes on working income increases the cost of labor for employers and reduces wages for employees. Hence, higher taxes on working income causes both employers to hire less and workers to work less. As economists like to say, the equilibrium quantity of work decreases because of employment taxes. Yet, it is people working that directly increases the wealth of the society. Even investments can only yield results if they put people to work. Hence, it makes no sense to tax working income more than investment or certainly inherited income.

On the other hand, if estate taxes are raised, people will continue to die at the same rate that they did before. Taxes have no effect because the supply of estates is perfectly inelastic, which is why the taxation of estates does not exhibit a downward Laffer curve at higher tax rates — on the other hand, taxes on work certainly does. In other words, higher employment taxes decreases the equilibrium quantity of work, but higher estate taxes has no effect on the death rate, and, therefore, higher estate taxes will directly yield increased tax revenue for the government. As economists like to say, there is no deadweight loss on taxing gratuitous transfers.

Laffer curve for gratuitous transfers, showing how the tax revenue collected increases proportionately with the tax rate.
The deadweight loss of gratuitous transfer taxes is zero — tax revenue increases proportionately with the tax rate, as can be seen from this graph of the Laffer curve for gratuitous transfer taxes.

Some may argue that the wealthy will take advantage of tax loopholes, but those loopholes only exist because Congress put it there, and Congress can easily take those loopholes away. After all, there are no significant loopholes for employment taxes, and if there were, Congress would quickly close it.

The estate tax taxes assets that would never otherwise be taxed, such as stocks or businesses, which aren't taxed until they are sold, and even then, the recipients would receive a stepped-up basis in the property, so their tax basis in the property would be the fair market value at the time of the decedent's death.

The estate tax also encourages charitable giving since such transfers are exempt from the estate tax.

Since the estate tax, in its present form, taxes mostly wealthy estates, it taxes people best able to pay.

As many people have argued, such as Theodore Roosevelt, the concentration of wealth can corrupt the political process, as evidenced by recent events in Congress, when the Republicans were willing to hold the country hostage, to thwart any other legislation, including a much-needed stimulus to the economy, unless the Democratic majority and President Obama agreed to extend the Bush tax cuts for the wealthiest 2% of Americans and to reduce the estate tax rate to 35%, with a $5 million exemption, or $10 million for a married couple, in spite of the fact that the country has incurred record deficits because of the Great Recession, a deficit that is all that much greater, because President Bush had started borrowing large sums of money, beginning in 2001, so that large tax breaks could be given to the wealthy, turning the budget surplus that he inherited from President Clinton into a major deficit even before the Great Recession began in 2007.

Arguments against the Estate Tax

There are many who will argue that the estate tax should be eliminated. No doubt that many of these people are wealthy individuals or beneficiaries. Republicans, who work for the interests of the wealthy and large businesses, believe that death should not be a taxable event; although they believe that work should be a taxable event — in fact, it is the most taxed event.

Some argue that the estate tax taxes money twice. But money is taxed repeatedly in different transactions. If I pay my housekeeper her wages for cleaning my house, I don't get to tell her that she doesn't have to pay taxes on those wages because I am paying her with money that I have already paid taxes on, namely, my own wages. A dollar bill is taxed repeatedly as it is used in financial transactions. People pay taxes based on their income, but through their inheritance, recipients can receive the money tax-free, without doing anything for it.

Some have argued that it benefits lawyers and accountants, who work for the wealthy to avoid the estate tax, and that such work has no real economic value, which is true, but this isn't really an argument against the estate tax, because it would be easy enough to close those loopholes that allow the estate tax to be avoided. Just removing the exemption amount would eliminate many of the legal maneuvers used to avoid the estate tax. As I mentioned before, there is no exemption amount for working income, why should there be one for estates?

The Republicans have often argued that farms and businesses must be sold to pay the estate tax. However, because of the generous exemption already available, most estates are not subject to the estate tax. Even so, the wealthy can easily afford life insurance that could pay the estate tax, or the law can be changed so that the new owners of farms or businesses can pay the tax when it is sold. Indeed, the tax law already allows estates with large farms and businesses to pay the tax bill over a 14-year period.