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Monday, January 14, 2013

Caron & Repetti: Occupy the Tax Code: Using the Estate Tax to Reduce Inequality

Paul L. Caron (Cincinnati) & James R. Repetti (Boston College), Occupy the Tax Code: Using the Estate Tax to Reduce Inequality, 40 Pepp. L. Rev. ___ (2013):

Inequality has been increasing in the United States. We should care about this increase because inequality contributes to a variety of adverse social consequences that persist across generations. There is also substantial empirical evidence that inequality has a long-term negative impact on economic growth.

For many decades, federal tax policy has played an important role in reducing inequality, although the impact of federal taxes on inequality has waxed and waned depending on the focus of elected officials. We argue that the estate tax is a particularly apt vehicle to reduce inequality because inheritances are a major source of wealth among the rich, and studies suggest that inherited wealth has a more deleterious impact on economic growth than inequality caused by self-made wealth. Although there are loopholes in the estate tax, it is still effective in moderating the amount of wealth that is passed within a family from generation to generation.

The major criticism about the estate tax—that it discourages savings—is inaccurate. Standard tax theory cannot predict the impact of the estate tax on savings and the empirical evidence is mixed. Moreover, the estate tax has a less harmful impact on savings than the income tax for two reasons. First, the event that triggers estate tax liability—death—is ignored by taxpayers during the period of life in which they are likely to be most productive. Second, the expected value of the estate tax’s effective rate is quite low during the period of life in which most taxpayers create wealth.

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Comments

Can anyone answer one simple fundamental question of fairness. Money subject to any estate tax has already been taxed once when it was earned. What gives the government the right to tax that same income again? Gift and estate taxes have always struck me as inherently confiscatory and without any validity (and no, I am not rich myself).

Posted by: Todd | Jan 14, 2013 8:37:05 AM

Todd,

I think one response might be the feature of our system wherein you get a stepped up basis in your assets upon death even though death is not a realization/recognition event. Thus, to the extent someone is holding highly appreciated financial assets it's possible that there's been no tax paid on the built-in gain.

That being said, the estate tax appears to be misdirected. As I understand it, it taxes the entire value of the estate, notwithstaning a particular individual may not have extensive built-in gain.

Fundamentally, reducing inequity seems like an inappriopriate goal for the estate tax with weak policy grounds supporting it, notwithstanding unconvincing claims that economic growth is influenced by inequity.

A better reform, I think, would be taxing the built-in gain as as a cost of the stepped up basis on death (w/ maybe a phase in or exclusion for small estates). With that change, I say get rid of the estate tax. Other reforms would be to look into all the structures that folks have to avoid the gift tax (GRATs, etc.) All the money that people spend structuring seems like an unproductive use of money to me.

Maybe if someone gave me $10 million I'd feel differently. I'd be up for it, if someone would like to do the experiment.

Posted by: Henry | Jan 14, 2013 10:19:49 AM

There is no double tax. The gift and inheritances are not taxed to the recipient. In a perfect world, we would not have an estate tax, but instead simply include gifts and bequests in the taxable income of the recipient. In effect, the estate tax is an imperfect substitute for the the tax that should be paid by the recipient.

Posted by: Jim | Jan 14, 2013 11:02:31 AM

Bullshit: Capital gains and transactions that are tax-deferred have not been taxed.

Bullshit: So what? There is no principle of taxation that says that "money" can only be taxed once. In fact, it is the norm that taxation occurs upon a recognition event, and death has been a recognition event for centuries.

Posted by: Anonymous | Jan 14, 2013 11:40:17 AM

(1) I've never found anything in our federal constitution suggesting that addressing income inequality is one of its purposes or within its enumerated powers. (2) Estate tax receipts, like all tax receipts, are redistributed largely without any consideration of income inequality. In fact, Congress re-distributes a big chunk of tax receipts to those who provide campaign contributions and other favors to members. Favoring the estate tax because it reduces inequality is a cover for ordinary government corruption.

And no, I'm not rich either. I'm just tired of dealing with a complex tax system that increasingly lines pockets instead of providing services.

Posted by: Ron | Jan 14, 2013 11:47:46 AM

It remains to be seen whether a higher estate tax rate leads to higher estate tax collection. As a personal matter, I am rich and I can assure you that I will pay minimal estate tax because I'm painfully aware that the compound effect of 40% income tax and 40% estate tax is effectively 64%. The estate tax has induced me to: (1) invest more conservatively (why risk an 100% after-tax for a 36% after-tax gain?) ; (2) gift to the next generation via loans and trusts ; and (3) actively plan for my lifetime spending needs (when interest rates are higher, I'll probably consider insurance products and annuities to help achieve these goals). Maybe these are good things, but I don't see them as unambiguous. I do believe that the state would collect more from me personally (and probably Warren Buffet, too) if the estate tax were on the order of 15% so that I didn't plan for it. I suspect that the state would collect more if the step-up in basis on death were eliminated (also, people would have less disincentive to collect capital gains in life -- and again Warren Buffet would pay more). Another tact might be to have inheritance be a taxable event, instead of death (I'd have to think about how that would influence my actions). Perhaps, the estate tax isn't about collecting money from me or Warren Buffet; maybe, it's designed to make us feel good about fighting the "evils of wealth".

It saddens me that statements like "because inequality contributes to a variety of adverse social consequences that persist across generations" are accepted uncritically as fact. I agree that poverty and its persistence across generations is an adverse social condition and leads to adverse social consequences. I disagree with the implicit assumption about wealth that there is a fixed amount of wealth bestowed by nature and that the wealthy are denying the poor access to their fair share. And if you're trying to protect my kids from the negative effects that wealth may have on them, I'd ask you to raise your own kids and stay away from mine!

Posted by: Andy G | Jan 14, 2013 11:53:05 AM

Built-in appreciation of assets held at death has not been taxed. While cash held at death may have been previously taxed, there is nothing surprising about double taxation -- it occurs all the time. If I use after-tax income to pay someone to mow my lawn, the income is taxed again to the service provider.

However, whether the tax code should be used as a vehicle for social engineering rather than as simply a method of raising revenue is another matter. One of the reasons the Code is so complex is that politicians have used it not just for raising revenue, but to achieve other goals. Tax incentives skew normal market forces and serve only to reward those with the best lobbyists.

Posted by: guy helvering | Jan 14, 2013 12:44:29 PM

Anonymous stated, "[Expletive deleted]..., Capital gains and transactions that are tax-deferred have not been taxed."

What's your point, Anonymous? Congress has chosen to give tax breaks to those types of income. You apparently want a tax break for gifts and inheritances. Someone else would rather give more of a tax break to gains and investment income. Shouldn't all income be taxed the same? If it were. there would be lower rates for all of us!

Posted by: Jim | Jan 14, 2013 1:46:08 PM

Well said Andy G. The problem is with the mindset embodied by our current President, who when asked if he was in favor of raising the capital gains tax even though it would likely produce less revenue responded "It's about fairness." Why should anyone care how much their neighbor has - your concern should be with your ability to provide for yourself and your family.

As to my original question, which admittedly was largely rhetorical, gifts and inheritances are inherently different from other taxable events. Other forms of income and taxable events result from mutually beneficial actions between two people (sales, exchange of labor for capital, an investment, a loan, etc). Gifts and inheritances are one way transactions; money is being transferred from party to the other (the goodwill or psychic benefit to the donor should not count as value).

After the initial taxable event when that money was earned, what use has it been put to to justify taxing it again? The net accession to wealth (good old Glenshaw Glass) by the donee is equally matched by the loss to the donor, and there is no other economic impact - so why tax it? To my meager libertarian brain, it looks like nothing more than an old fashioned confiscatory wealth tax.

Posted by: Todd | Jan 14, 2013 2:56:22 PM

Every municipality in the US taxes wealth in the form of real property every year at rates something like 1-2% annually. Why? To raise money for public purposes, of course. So why should not the federal government tax wealth every 35-40 years for the same or similar purposes? (You might argue it's unconstitutional, but the Supreme Court long ago decided otherwise.) The argument that the "money" has been taxed once already is [expletive deleted] for the reasons already given: it's done all the times (what else are sales taxes?), the Waltons and the Zuckerbergs have never paid income tax on their stupendous capital gains, and death is a reasonable time to catch up with them. And there's no theorectical objection to taxing donative transactions (as we do now) as accessions to the wealth of the recipient. Yes, in theory we could tax all appreciation at death in lieu of an estate tax, and some countries do, but there are big practical problems that just recently were extensively debated in light of EGTTRA (who knows the basis after 40 years?) Prof. Batchelder at NYU has studied the idea extensively, for those who are truly interested.

Posted by: Mitchell S. Fishman | Jan 15, 2013 12:59:43 PM

Todd,

I'm confused by your argument because it seems to be based on your assumption that payments for psychic benefits or goodwill don't count as consumption.
You state:
"Gifts and inheritances are one way transactions; money is being transferred from party to the other (the goodwill or psychic benefit to the donor should not count as value). After the initial taxable event when that money was earned, what use has it been put to to justify taxing it again? The net accession to wealth (good old Glenshaw Glass) by the donee is equally matched by the loss to the donor, and there is no other economic impact - so why tax it?"

Why should we dismiss goodwill or psychic benefit as irrelevant? When I pay to watch a movie, the only benefits I receive are psychic in nature. We fully tax those transactions--I have a nondeductible personal expenditure and the movie theater has income. The Chicago economist, Becker, spilled a lot of ink discussing the benefits that donors derive from making gifts. The psychic benefits I obtain from making gifts to my spoiled grandchildren are every bit as real as the benefits I obtained from watching "The Hobbit" over the weekend. That should be difference between (1)the psychic income I derive from paying for my grandchild's car and the accession to wealth she experiences from receiving free transportation and (2) the psychic income I obtain from making some other nondeductible personal expenditure that results in an accession to wealth for the recipient.

Posted by: Jim | Jan 15, 2013 3:47:49 PM