Estate Tax Reasoning

Over at Warren Reports, a new blogger named Tijana Divornic asked what area of taxation the readers would want to know more about. I wrote that I wanted to know more about the estate taxes. All I could remember from my law school studies is that the purpose of the estate tax was to prevent dynasties.

It is often referred to as the "Death Tax" by conservatives for rhetorical reasons, because it makes the tax so unfair. After all, why would it be right, conservatives argue, to tax a person after they are dead.

Anyway, Ms. Divornic complied with my request. Here are some of my favorite quotes from her article and the responses that followed:

The estate was first created to help fund WWI. Besides the revenue need (collected from those who can afford it), the justification for the tax is redistributive. Congress wanted to prevent the rise of a “leisure class” that would control most of the wealth without having to work, hence the estate tax is meant to achieve equality of resources (making wealth a function of work, rather than status).

Besides property owned at death, the estate tax also encompasses property given away during life in which the decedent had retained certain interests. (The IRS has really complex rules for this). The rates have changed over the years - starting at 10% and growing to 70% in 1935. (It's somewhere around 45% now - not quite sure where we are on the phasedown).

The tax only applies to a small percentage of the extremely wealthy (some studies suggest about .5% of the population). The short reach is because of the size of the exclusion; most people’s estates don’t come anywhere near this amount. And as always, there a lot of ways to avoid a substantial portion of the estate tax (for instance making tax-free inter-vivos gifts).

...

One of the practical arguments often made for the estate tax is that it ensures that the wealthy are being taxed on capital gains. When appreciated capital assets are left to heirs, under current law they get a basis step up. So because the capital gains are never realized, they are never caught by the income tax. The estate tax, however, taxes the transfer. IRS 1014 and 1022.

A comment from aMike said this:

As far as I know, the idea first received wide distribution in the United States from a most peculiar source, the Robber Baron and Philanthropist Andrew Carnegie. Way back in 1889 he wrote a tract called The Gospel of Wealth.

Carnegie argued against the bestowing of large estates upon the children of the wealthy primarily on two grounds. First, it was harmful to those who received the inheritances (I wonder if we'd call this the Paris Hilton effect today?):

Carnegie said:

Why should men leave great fortunes to their children? If this is done from affection, is it not misguided affection? Observation teaches that, generally speaking, it is not well for the children that they should be so burdened. Neither is it well for the state. Beyond providing for the wife and daughters moderate sources of income, and very moderate allowances indeed, if any, for the sons, men may well hesitate, for it is no longer questionable that great sums bequeathed oftener work more for the injury than for the good of the recipients. Wise men will soon conclude that, for the best interests of the members of their families and of the state, such bequests are an improper use of their means.

Second, he argued that largely taxing inheritances away was beneficial to the state and community as well:

The growing disposition to tax more and more heavily large estates left at death is a cheering indication of the growth of a salutary change in public opinion.... Of all forms of taxation, this seems the wisest. Men who continue hoarding great sums all their lives, the proper use of which for public ends would work good to the community, should be made to feel that the community, in the form of the state, cannot thus be deprived of its proper share. By taxing estates heavily at death, the state marks its condemnation of the selfish millionaire's unworthy life.

Then, in response to the argument that people often lose the "family farm" because of the estate tax, ElaineinIN said this:

The thing that the purveyors of the "death tax" garbage don't like to tell us is that there actually already ARE provisions in the estate tax code that give preferential treatment to farms and small businesses. For example, Section 2032A is called special use valuation... if you have land that is being actively farmed, it is valued as farm land, even if it would be worth more per acre if it could be developed. Also, Section 6166 allows certain estates that have concentrations of stock, like family owned businesses, to pay the tax in installments over 10 years at like 2% interest so that the business doesn't have to be forced into liquidation.

And amusingly enough, Section 2057 had a deduction for qualified family owned business interests, which basically excluded certain interests in businesses that were being run by family members. It was limited in value and the rules were really tight, but it was there. What happened to it?

It was repealed as part of the SAME bill that repealed the estate tax. Because they cared SO much for small businesses....

Basically, if you read through the reasoning, the idea is that we, as a matter of public policy, want to encourage wealth created by work rather than simply because someone was born in the right family. It is also considered better if the money keeps getting reinvested in the economy rather than hoarded.