Thursday, 14 April 2005

Eliminate the "Death Tax", but ...

As Congress and the Republicans continue to shift the tax burden exclusively toward labor income and away from accumulated wealth [House bill passed] , [Senate bill pending], I find myself reflecting on the notion that some believe money which has been taxed once should be exempt from tax in the future. This is one prime argument against the estate tax, but one which I find phony.

On the other hand, there is something unseemly about the feds hovering over the estates of the dead, waiting to extract their portion before the remains are distributed to heirs. Indeed if a fabulously wealthy person wanted to leave the entirety of their estate to charities and the indigent, then I too would find it offensive for any portion to be taxed before being distributed according to the wishes of the deceased.

A few years ago, before I investigated this, I had always assumed that the estate tax was really an inheritance tax, which strikes me as the reasonable and fair way to collect from those who can afford to contribute their fair share toward our collective coffers. So put me on record as being opposed to the estate tax, BUT simultaneously in favor of instituting an inheritance tax with a MODEST exemption - something in the order of 15K to 50K, not the insane million dollars, which is currently the case.

I wondered why the feds taxed estates rather than inheritance to begin with, and found part of the answer here.
The Committee [in 1916] recommended an estate tax rather than an inheritance tax because many states already imposed inheritance taxes. It felt that the estate tax helped to form a well-balanced system of inheritance taxation between the Federal Government and the various states and that an estate tax could be readily administered with less conflict than a tax based upon inherited shares.
Ease of administration and balance with existing state taxes were the rationale in 1916, and I wonder if they remain legitimate issues today. It is easy to imagine concerns around ease of cheating for inheritors. I wonder if filing of documents with the IRS by an estate for each beneficiary inheriting over some threshold amount would be less onerous than the current paperwork associated with estate taxes.

To be sure, there are details and consequences which are well beyond my ability to fully apprehend, but the logic of taxing windfall inheritances seems fundamentally sound and fair to me. If one accepts the notion that government does have a role to play in providing for societal concerns that otherwise would not be attended to, then the necessity of a tax which calls on citizens to contribute to those functions as they are capable is clear. If income from labor contributes to such an ability, then certainly income from inheritance does as well, and I see no logic in exempting inheritances up to one million dollars. That the deceased paid taxes on his/her income during his/her lifetime, should have no bearing on whether the beneficiary is exempt from declaring inheritance as part of their income. In a healthy economy money moves all the time from salary to purchase to expenses to salary, etc. We don't exempt someone from payroll taxes because they were paid for by sales which had been taxed.

There is a legitimate concern about assets with a large value for which a tax could not be paid without liquidating the asset. For that I would suggest deferred taxation at the point of the sale of the asset. The gain would then be taxed, and the basis of an inherited asset would be zero plus any portion of the exempt portion of the inheritance applied toward that asset. The same would go for inherited stocks and bonds.

While I'm changing the tax code, ;-) here are some more:
  • Remove the cap on the Social Security tax while reducing the rate.
  • Exempt the first $500 of interest income.
  • Capital gains are simply income; tax at the normal rate - if anything tax gains from very briefly held securities at a higher rate.
  • Do away with the mortgage interest deduction (from which I benefit mightily). After all, aren't renters also paying this for their landlords - only in a disguised manner?
  • Do away with lots of other special deductions based primarily on the strength of some lobby.
  • Keep the deduction for charitable gifts, AND make it claimable on top of the standard deduction.
  • Remove the "marriage penalty".
  • Keep the deduction for state taxes paid, but only if not taking the standard deduction.
  • Adjust the tax rates, which would remain on a progressive sliding scale, to account for all of these changes and begin to close the deficit gap. (I'm guessing they would actually go down due to inheritance taxes, removal of deductions and special capital gains rates.)
So that's a lot of changes, and I don't claim to be able to anticipate all of the unintended consequences. Certainly studies would need to be done to anticipate the effects. But the current system is broken, clearly benefitting those with access to power at the expense of those without that access. It's hard to get people to take to the streets to affect tax code changes, but the Republicans have been able to mobilize on behalf of some bizarre constitutional amendments lately - surely we can do better. Probably not during this administration, but maybe someday.

One more thing: I just don't buy it that a national sales tax is the way to go, though the people at Fair make an interesting case for it, accompanied by a government 'rebate' to EVERYBODY to cover the cost of consumption taxes for the very poor. Ultimately, they're saying that our system of government is too corrupt for the changes that would spread the burden fairly to ever become law. They may be right, but we can keep working at it.


-epm said...

Walker Lives!

One question: Aren't charitable bequests exempt for the estate tax? That is to say, do estates have exemptions for charitable giving before the tax is applied.

Very interesting post. I always thought it was an inheritance tax. That is, the beneficiaries of the estate paid the tax out of the estate. Is there really a difference between paying the tax after the estate is distributed versus before it's distributed.

I like the deferment of essentially non-liquid assets, such as farms or a building. Seems fair.

Walker said...

I believe you are correct that charitable bequests are exempt, though perhaps to a particular limit. The point here is that the current estate tax requires the executor to pay the tax out of the estate before disbursement. This seems an awful burden to be imposed at a likely time of tragedy, and is not reflective of the impact on the inheritors, except to delay their inheritance. No doubt it gets funds to the federal government more quickly and assuredly than would happen if it is left to the inheritors to report their income as part of their annual tax filing the following year.

But a change to an inheritance tax would change the amount due in what strikes me as a much fairer way. Imagine two one million dollar estates. One leaves everything to an only child who is already wealthy. The other splits the estate among 10 inheritors, some of whom really are not at all wealthy. The incremental $100 K windfall for the multiple inheritors would be taxed at a lower rate and after an initial exemption than the $1 million dollar windfall for the only child.

And by the way, I forgot to mention that my tax code changes would include reinstitution of income averaging so as not to punish too severely those who are ordinarily taxed at a much lower rate.

gary said...

Seeing as how you all don't like the fair tax.That I support I have a proposal .Lets pay our tax according to our political affiliations then everyone will be happy.Independants like me hate taxes so they pay 5%,republicans somewhat like taxes so they pay 25%,democrats just love taxes so they pay 75%.And you must vote as your taxes are assessed.What do you think of this idea Gary