Unfortunately, this tax is not simple, so I’ll have to go into some details that I’m sure some will find boring. But once I’m through with the details I will explain the reasoning behind my suggestions. Inheritance tax, also sometimes referred to as “the Death tax”, is incurred by the recipient of an inheritance. Estate tax is very similar in nature, though it applies to the estate before being passed on to an heir. Different countries have different formulae for wealth transfer at death. Canada has no inheritance tax and instead applies capital gains taxes at fair market value on the assets (estate) as if they have been sold. Any capital gains on these assets is then taxed at 50 percent. There are exemptions like transfer of assets to a spouse or leaving “marketable securities to a registered charity through your will”. Primary residences and Lifetime Capital Gains also have their own exemptions. In the United States, estate tax is federal and inheritance tax is left to the state to decide.
Obviously this debate could be framed in many ways, but federal estate tax in the United States is easiest to address. The basic exemption is the one I want you to understand. It can be found here. Also shown is the table for tentative tax, which isn’t worth getting into. As you can see, the first $5.49 million is exempt. Estate tax only applies to amounts exceeding that first $5.49 million. So if an individual’s estate is worth $10 million when they die, they will be taxed at 40% on $4.51 million (without any additional exemptions). This means the estate tax will amount to $1.804 million. So if there were a single heir, that person would inherit $8.196 million. My proposition is to have brackets that scale percentage based on the value of the estate. Let me explain.
I think an exemption makes sense, but with an adjustable percentage, that exemption could start quite low. I don’t have exact amounts worked out, but with a reformed tax the exemption could apply to the first $500,000 and then an estate valued between that and $1 million could be taxed at 1 or 2%. As the value of the estate rises, so does the percentage, in much the same way income tax brackets do. The percentages could also be made to apply ONLY to the wealth within that bracket, also mirroring income tax. This is discussed at more length here. The point is, having a flat 40% tax on taxable estates makes little sense. The higher the net worth/estate value, the higher the percentage taxed on wealth that falls into that bracket. This suggestion is just a marginal tax rate being applied to estates.
I completely agree with what Milton Friedman says when he addresses the idea of 100% inheritance tax. Having a 100% inheritance/estate tax would disincentivize business and cause people to spend frivolously on luxuries and entertainment. But I don’t see how having a fairly high estate tax would yield these same results. If people can only pass on say, 60% of their total wealth, are they less likely to try to earn more? I don’t think so. Of course if they’re only able to pass on 5% of their total wealth they’re likely to spend it, but that isn’t what I’m suggesting. I think a marginal estate tax would allow for wealth exceeding $1 billion to be taxed at say, 80%, and still not destroy incentives to earn.
So absolutely, I can see why a 100% (or close to it) estate tax is bad, but I think raising it (especially in the sense of scaling to wealth) makes sense. I see no adequate justification for repealing estate tax (or lowering it for that matter). Peter Schiff argues that the wealthiest Americans don’t even pay much estate tax because they use loopholes in tax code, lawyers and the like to essentially avoid paying these taxes. Here’s the full podcast for context. The problem with this argument and others involving inefficiency (at generating government revenue) is that they address estate tax as if corruption is built in. If we can do something about heavy lobbying in regards to tax reform then we can start to challenge tax avoidance and evasion. I don’t blame business moguls when it comes to avoiding taxes within legal parameters. Unfortunately many of these tycoons attempt illegal methods as well (evasion). Enforcing stricter policies is a good way to make businesses more accountable. No, I don’t mean more regulation, I mean reforming current regulations to make them more concise and to include fewer loopholes. A reform to estate tax like the one I suggest must coincide with a reform in the way tax policies are enforced or it’ll be insignificant. I recognize that it’s not an easy task. Further discussion here.
As far as fairness goes, the current U.S. estate tax does not seem unfair to me. As stated, I believe it could use reform, but certainly not in the direction of reducing the burden on the wealthy. Schiff and other opponents of the estate tax imply that this tax is targeting small family business owners and farmers. I would hardly call a $5.49 million business a small family business. It’s a substantial estate at that point. And beyond that point, you’re only taxed 40% of the additional wealth. It takes until roughly $20.5 million to be taxed even 30% of your total wealth. That doesn’t seem so unreasonable. As far as farming goes, it’s a relatively expensive industry, so I can understand issuing some exemptions. But those exemptions should be for owners of small farms with high costs for assets (equipment, machinery, inventories). I think exemptions can also be given on the basis of renewable energy and other sustainability practices (as long as they don’t become vessels of further tax avoidance).
If the heir to a business has to sell their parent’s business in the case that they can’t afford the assets because of estate tax… is that truly a bad thing? Of course they will have valuable skills if they were an apprentice to their parent, but those skills do not automatically qualify the heir to take over as CEO. They would certainly already have an advantage if they sought employment with whoever purchases the business from them and they could work their way up to the top like everyone else is required to do.
I would love to hear some alternative perspectives and criticism of my suggestion of creating a bracket system for estate tax.