Estate Taxes

Q. Are estate taxes a fair form of taxation?

A. I have been studying the topic of estate taxes for some time, and after looking at all the research and the ethical arguments, I have concluded that this form of taxation is underused.

Currently the inheritance tax in the United States applies only to rather large estates, so the majority of families are completely exempt. On very large estates the tax is very large, unfairly so; this is compensated by a variety of loopholes, which guarantee that a clever wealthy person (or a wealthy person with clever lawyers) often pays virtually nothing. For this reason the US estate tax is sometimes called an "idiot tax," due to the perception that large estate taxes are paid only be people who don't take the trouble to avoid it. A smaller but more consistently enforced tax would be fairer and less wasteful.

Currently there is a powerful movement in America to abolish the estate tax altogether, and in Israel there is only a nominal tax on inheritances.

The arguments in favor of an inheritance tax are simple. The most important things economists look for in a tax are equity (fairness) and efficiency. Taxes are considered fair when everyone pays their fair share. Most people consider a tax fairest when those with the most means pay a larger fraction than others; this is known as "progressive taxation." Since most people have income, an income tax is considered a fair tax, and it is not surprising that a progressive income tax is the main source of revenue in virtually all advanced economies.

Inheritances are a very important source of income, meaning that equity considerations should encourage taxing it, so that we don't have two people with the same income where one pays taxes and the other escapes. Furthermore, since rich people tend to have offspring who have obtained significant advantages during the parent's lifetime, most children of people with significant estates tend to have above-average income already. It seems strange to give them a tax-exempt source of income when working people with far less income are paying taxes on all of their income.

Inheritance taxes are progressive even if there is a flat rate, since the poorest citizens don't have significant wealth when they die, and so they would pay virtually no estate tax, especially if we maintain the exemption at some reasonable level.

Taxes are efficient when they don't discourage productive activity or encourage unproductive activity. Very high income taxes have been shown to discourage earnings, and so the over-50% rates which were common a generation ago are now rare. But moderate estate taxes have not been shown to be a significant disincentive on productive activity. Much wealth is not accumulated with any intention to bequeath it. Some is just left over from what was saved for what was hoped to be a more prolonged old age. Other wealth is accumulated because it gives power and prestige to the owner, even if he or she never intends to spend it. I don't condemn this motive because often people use this power and prestige for admirable ends, for example to promote charitable projects. Building a large business provides an immense benefit to society, and if the incentive for doing so is the standing it provides I think this is a fair tradeoff. Many large fortunes are accumulated by people who were never thinking of the next generat on when they acquired them.

However, research supports the view that many people are very interested in passing wealth to the next generation (not only to their children), and that this is an important incentive in their saving. It's true that taxing these estates will give such parents less incentive to save, but if the tax is not excessive I don't see any reason this effect will outweigh the other benefits of the tax. Besides, the inheritance tax will give the children much more of an incentive to work and save.

Very high estate taxes combined with significant loopholes means that much effort is invested in avoiding taxes. I don't fault professionals who engage in such elaborate estate planning since they're only doing their job, but I don't see why the tax system has to encourage wasting the considerable talents of these dedicated individuals in what is essentially a socially wasteful activity. A modest estate tax without loopholes would not significantly discourage productive activity and would avoid encouraging wasteful efforts by estate planners.

It has been argued that an estate tax is a double tax, since the parent has already paid taxes on the money as he or she accumulated it. This is certainly true, but it is true of many other taxes as well. Sales taxes are paid out of income which was already subject to income tax; corporate dividends paid to individuals are taxed even though the income of the company already went to corporate taxes. Double taxation does present a problem, but it's not the sole consideration in creating a tax system. In the case of estates it's not clear if the tax should be considered double at all. If the estate is only an "afterthought" or if they are viewed as a kind of payment from parent to child, then we could say that the bequest is an entirely new transaction.

In Jewish communities, bequests have generally been treated like ordinary income for various kinds of levies. One source of communal funds is the private tithe; noted authorities such as Rabbi Yeshayahu Horowitz (1) Shelah, charity and tithes) and Rabbi Yechiel Michal Epstein (2) rule that inheritances are subject to tithe, even though the parent already separated tithes from his own income. Rabbi Horowitz writes: "Now that the son has acquired [the funds], why shouldn't he tithe what God has provided him? It's not germane to argue that the son is merely in place of the father, since the son is an independent owner." And mandatory community taxes have also often treated inheritances like ordinary income. (3)

A modest, simple and consistently applied estate tax is a fair levy and makes a contribution to having an equitable and efficient tax system. And such a system is in harmony with the practice of many Jewish communities.

SOURCES: (1) Shnei Luchot HaBrit, laws of charity and tithes (2) Arukh HaShulchan, Yoreh Deah 249:6. (3) Responsan Mayim Amukim II:63 – Raanach