The purpose of taxation is to arm society with the means to provide civilization. U.S. Supreme Court Justice Oliver Wendell Holmes once said, “I like to pay taxes. With them, I buy civilization.”1 But, the Supreme Court, in McCulloch v. Maryland,2 noted, “The power to tax involves the power to destroy.”
We can’t begin to discuss here the “best” philosophy of taxation but were we to do so, we wouldn’t be among the first. For instance, in 1 Samuel 8:15-17, the God of the Hebrew Scriptures tells Samuel to warn the people that a king will take a tenth of their grain and flocks, and Plato notes that where an income tax is imposed, the just will pay more and the unjust less.3
An alternative to imposing taxes might be to have the government print money. That probably would be unacceptable, although a huge amount of the funding of government occurs that way.4 Also, it causes an “inflation tax,” that is, it reduces the value of what members of society own and earn.5
Taxation persists. In the United States today, we impose thousands of different taxes on ourselves. The Internal Revenue Code, which is the United States’ principal law to extract tax, may be the most complicated law in the world.6 Tax advisors would like to claim it’s because we’re so clever, but it isn’t we who are clever but the lawmakers who understand that the tax law can destroy or favor different taxpayers, often in ways hidden from the public and thus “inspire” contributions and support for those very lawmakers. On the way to paying for civilization, our tax laws benefit some at the expense of others, for political and other reasons.7
We think that it might be best, in theory, to have a tax system that promotes the economy to the greatest extent possible. Indeed, William Gladstone, in 1860 as chancellor of the exchequer noted for Parliament that:
Our high taxation is not a reason for stopping short in our commercial reforms; it is the reason why we should persevere in them. For it is by means of these reforms that we are enabled to bear high taxation.8
Gladstone’s view was that an expanding economy enables higher levels of taxation. Regardless, even if we knew how to construct a tax system that would promote the maximum expansion of the economy, we would still confront an expanded and expanding economy that wouldn’t distribute those benefits equally to all. And, we would be left with issues not susceptible to expert analysis but best left to the sovereign people: Who should benefit? Those who produce the most for the economy, for society (are those two different?) or those who pay in the most?
Estate Tax is Different
In any case, we think the estate tax is different from most other taxes and believe it helpful to call out some of those differences. The owner of property never pays an estate tax. In that sense, it benefits the most productive the most. Other taxes extract a price against those who produce the benefits for the economy, from income taxes to excise taxes to business taxes to almost all other taxes.
The only incentive that the estate tax would seem to inhibit is that of accumulating assets for one’s heirs. We’re aware of no compelling empirical research demonstrating that the wealthy are in fact inhibited from wealth accumulation by an estate tax. Not persuasive but indicative perhaps would be the broad opinion of estate planning and financial professionals that in fact the wealthy don’t work or accumulate either less or more in response to the wealth transfer system. Of course, the back-of-the-napkin sociologist might argue that great fortunes were accumulated before there was an estate tax (think Rockefeller, Ford, Carnegie) and after the estate tax rates were reduced from mid-20th century highs (partly by direct rate reductions and partly by the expansion of loopholes) (think Buffett, Gates, Zuckerberg, Bezos).
A corollary contention is that individuals just simply give up because their greater wealth will be eroded at death, thereby making the economy less productive. It is, perhaps, a reasonable observation that if someone who could make more money passes on that opportunity, another (more greedy and, perhaps, younger and less wealthy individual) will step up and take the opportunity to generate the wealth.
Would those who worry about incentives to build wealth favor a wealth tax rather than an estate tax? An annual wealth tax would reduce wealth and thus inspire efforts to rebuild.
Repeal the Estate Tax?
Considering how much attention is given to the estate and gift tax, why isn’t it just repealed? It’s just not that simple. As one article pointed out, there would be trade-offs.9 For example, repealing the gift tax would likely result in more income shifting (to family members or entities in lower income tax brackets), which would result in a loss of additional revenue (above the loss from the repeal of estate and gift taxes), which presumably would have to be made up from other sources.
The primary arguments for repeal, in addition to the concern about incentives noted above, include: (1) it raises so little revenue that it should disappear; (2) it’s a double tax; (3) it kills small businesses and discriminates against farmers; (4) it’s just too complicated to be in our tax system; (5) who cares because there are lots of alternatives we could use; and (6) estate tax reform is impossible because of politics. Let’s consider each of these.
The estate tax doesn’t raise enough revenue to justify it. This is the easiest complaint to address. The argument is circular. Of course, if you have exemptions of almost $12 million and a 40% flat rate, you raise less than if you lower the exemption and graduate the rate. Suppose we returned to a $60,000 exemption and the rates of the late 1970s; would that raise enough revenue to justify the estate tax? We suspect the argument would then be that the estate tax is too onerous to be retained.
Is it a double tax? Income is taxed many times in our economy. For example, a barber earns $1,000 and pays $200 in income tax, leaving him with $800. He uses the $800 to pay his grocer. The grocer (after proper expenditures for the cost of her goods) pays $150 in income tax, leaving her with $650, which she uses to pay for accounting services. The accountant winds up paying $200 in taxes (a higher percentage than either the barber or grocer for many possible reasons), and he uses the $450 to buy something else. The original $1,000 the barber earned has been taxed again and again—indeed, the tax collector, who took in $550 of taxes, also spends the money. If we added in excise taxes, we would have even more taxes paid on the same dollars as they amble through the economy. Does that double, triple, octuple, etc. taxation offend us? Other than the general plea for lower taxes—a universal impulse as deeply rooted as the plea for balloons on your birthday—it doesn’t seem to.
Is the estate tax different? Well, Bill Gates will never pay any income tax on his profit on any Microsoft stock he holds at death. In fact, under our current system, neither he nor his inheritors (maybe his wife) will ever pay income tax on the profit in the stock on account of the income tax-free step-up in basis that occurs at death—which occurs even if no estate tax is paid. Bill Gates is a growth accumulating taxpayer.
But, now let’s consider the income saving taxpayer, who earns income, pays income tax and dies with the after income tax earnings. Those earnings have already been income taxed. Isn’t there now a double tax on them? Well, it seems no more than the having the grocer pay income tax on the amount paid to her after the barber already paid tax on the same dollars. Indeed, we again have a separate taxpayer. As is well known, the estate tax isn’t borne by the decedent (the transferor) but is, in effect, borne by the transferees (that is, the inheritors). It might be contended that, even if it were fair to tax the accumulated wealth, the tax burden wouldn’t fall on the individual who accumulated the wealth, but on the recipients, who might not be so wealthy.
Indeed, as unfair as inheritors might think the estate tax is because it’s taking almost half of their inheritance, with a 40% federal estate tax, that’s almost the same reduction in wealth the inheritors face if they have one sibling who equally shares the ancestor’s wealth. If there are three siblings, more is likely diverted by the parents than by the tax system. In fact, older children should preach the strictest birth control for their parents to ensure their “rightful” inheritance (we might go so far as to say that the child who welcomes a newborn to the family has evidenced a misunderstanding of the estate tax system for the first, but perhaps not the last, time).
Those who worry about double taxation should logically argue for imposition of a capital gains tax at death. That would put everyone on an even playing field—the growth accumulating taxpayer and the income saving taxpayer. Although it would add complexity, capital gains could be indexed for inflation and then taxed at death to avoid the complaint that Uncle Sam is causing inflation through the Federal Reserve (a common complaint from the 1970s when we had high inflation) and then taxing it.
The estate tax kills farms and other closely held businesses. There are many provisions in the Internal Revenue Code that favor the estates of owners of farms and other closely held businesses. There’s no evidence that the number of farms in the United States has been reduced on account of the estate tax.10 Farms fail and farmland is sold all the time. It’s not on account of the estate tax but due to other government policies, economic factors and failure, in some cases, to manage farms in the best way possible. If Farmer Jones does a poor job and the farm must be sold, presumably Farmer Brown will buy it. The failure of a farm doesn’t mean it goes out of existence. If the county, state or country needs a certain number of farms (or what they produce), the economics will result in the correct number of farms and their produce. The law of supply and demand will win out every time. There are arguments that “family farms” are fundamentally different from “corporate farms,”11 but eliminating the estate tax won’t eliminate corporate farming.
The argument also is that the estate tax “kills” other businesses. A frequently referred to example is the loss of the Miami Dolphins football team by the Robbie family allegedly attributable to estate tax when the owner, Joe Robbie, died.12 Even though other reasons (such as family disputes) may have been the real cause—guess what! The Dolphins team still survives to this day. Why? Because someone else acquired the franchise.
And, it’s not just big companies that survive. Suppose in your community there’s a need for three pizza parlors. One goes out of business maybe on account of taxes, maybe on account of poor management or maybe for other reasons. But, if the community needs three pizza parlors, the law of supply and demand will mean there will be three (although, perhaps, the one that ended will be absorbed by one of the survivors or two new smaller ones will emerge).
The estate tax system is sufficiently porous that with a little planning, the small business and the family farm can easily pass to future generations unscathed.
The estate tax is just too complicated. As noted earlier, the IRC may be the most complicated law in the whole world. The estate and similar taxes are just a tiny part of our tax system. A standard CCH two volume edition of the IRC measures about six inches thick. The entire estate, gift and generation-skipping transfer tax provisions are only about one-quarter of an inch thick—about a 24th of the whole IRC. But, there’s no denying that the wealth transfer tax system is complex especially because it has to mesh with state law rules of inheritance.
But, it could be greatly simplified by eliminating the: large exemption; marital deduction (and the complex rules it spawns); special valuation rules for closely held businesses and farms; discounts in valuation for artificial structures (such as family partnerships); and the complex deferral payment of estate tax rules.
Substitute another tax for the estate tax. What would that tax be? Unless the new tax is targeted towards the wealthiest then, by definition, it will shift the tax burden away from the wealthy to the less wealthy. Of course, that could be made up; we could eliminate the estate tax and substantially increase the income tax, including taxation of dividends and capital gains, so that we’re giving to the wealthy on the one hand and taking away on the other. Arguably it’s not wise to tie so much of our revenue to one form of taxation.
Perhaps we could create a different tax, for instance a value added tax?13 A consumption tax by nature is more regressive than an income tax or an estate tax because it taxes spending, and the wealthy save more than those who are less wealthy. So, once again, great adjustments are required if the wealthy are to be taxed at the levels they are now.
A political argument. There’s one other argument to consider. We discussed in an earlier dialogue14 the notion that there’s no political will to reform the estate tax to make it effective. The wealth transfer tax system is so riddled with loopholes that you pay for estate tax advice or you pay the estate tax. That’s a dumb way to run a country. One of us (Berry) is more skeptical that loophole closing can occur in any realistic political environment and thus would be more inclined than the other of us (Blattmachr) to scrap the system in favor of something else.
We agree and believe strongly, though, that those who want to repeal the estate tax need to address what tax or taxes would be increased in lieu thereof. It’s bogus to contend that we can do just fine without the revenue from any particular tax unless those pushing for its repeal can show that economic activity would be so enhanced by the repeal that other taxes (for example, income tax) would make up for the loss of revenue from the one repealed. For example, perhaps we should do what Canada did: Repeal the estate tax and impose a gains tax at death (with an inflation adjustment as mentioned above). Or, perhaps, we should cause all gifts and inheritances to be included in income—after all, they’re income in an economic sense.15 There are lots of alternatives that could be considered. Or, just retain and reform the estate tax. Some famous Americans have long believed the estate tax is necessary to even out the costs of the government compared to the benefit of being in the American system. Teddy Roosevelt was one.16 Andrew Carnegie was another.17
It’s All About the Taxes
Here’s something to consider. We have to impose taxes to run the country. The tax system will never be satisfactory to everyone. Arguments about placing extremely heavy taxes on those best able to afford it will certainly result in loss of revenue from tax fraud to tax avoidance. Go visit the Museum of the American Revolution in Philadelphia. It’s a great facility. And, the first several panels are about what caused the revolution, and the vast majority of reasons are about taxes.
Endnotes
1. Compania General De Tabacos De Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100 (1927) (See Dissent).
2. McCulloch v. Maryland, 17 U.S. 316 (1819) (emphasis added).
3. Thrasymachus in Plato, The Republic of Plato, Book 1, Part IV [343e].
4. For deficit spending by the federal government, seewww.thebalance.com/us-deficit-by-year-3306306.
5. www.mercatus.org/publications/government-spending/where-does-government-get-money-it-spends.
6. The income tax on individuals is the primary source of receipts by the federal government. It comes in at 45%. Medicare and Social Security taxes produce around 39%. Corporate tax comes in at 12%, while estate and gift taxes produce only 1%, www.mercatus.org/publications/government-spending/where-does-government-get-money-it-spends.
7. See generally Philip M. Stern, The Rape of the Taxpayer (Vintage Books 1974).With respect to the estate tax, Death by a Thousand Cuts: The Fight Over Taxing Inherited Wealth (Princeton University Press 2006) by Michael J.Graetz and Ian Shapiro is a fascinating tale of how the estate tax came to be slated for repeal, or not, in 2001.
9. Jonathan G. Blattmachr and Mitchell Gans, “Wealth Transfer Tax Repeal: Some Thoughts on Policy and Planning,” 90 Tax Notes (Jan. 15, 2001).
10. Seewww.newyorker.com/magazine/2020/08/17/how-suffering-farmers-may-determine-trumps-fate.
11. See generally the work of Wendell Berry, including The Unsettling of America (Counterpoint 1977; revised 1996). (Wendell Berry and author Turney P. Berry aren’t related.)
12. “When Joe Robbie, founder of the Miami Dolphins football team, passed away in 1990, his family had to sell the franchise to pay a reported $47 million in estate taxes,” www.forbes.com/2006/12/04/estate-tax-estee-lauder-irs-ent-law-cx_mf_1204estatetax.html#4e70f846c4b9.
13. A “value added tax (VAT) is a consumption tax [somewhat akin to a sales tax] placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale,” www.investopedia.com/terms/v/valueaddedtax.asp.
14. Jonathan G. Blattmachr and Turney P. Berry, “Should It Stay or Should It Go?” Trusts & Estates (September 2016).
15. “‘Full income’ refers to the accumulation of both the monetary and the non-monetary consumption-ability of any given entity, such as a person or a household,” https://en.wikipedia.org/wiki/Income.
16. Teddy once said:
We grudge no man a fortune in civil life if it is honorably obtained and well used. It is not even enough that it should have been gained without doing damage to the community. We should permit it to be gained only so long as the gaining represents benefit to the community … The really big fortune, the swollen fortune, by the mere fact of its size, acquires qualities which differentiate it in kind as well as in degree from what is possessed by men of relatively small means. Therefore, I believe in a graduated income tax on big fortunes, and … a graduated inheritance tax on big fortunes, properly safeguarded against evasion, and increasing rapidly in amount with the size of the estate.
17. “Of all forms of taxation, this seems the wisest … By taxing estates heavily at death the state marks its condemnation of the selfish millionaire’s unworthy life.”