The Free Market 15, no. 9 (September 1997)
At last, the Republican Congress has proposed cutting death taxes. It wants the exemption to be raised from $600,000 to $1 million. Not bad for a start. But if Congress is serious about reducing the tax, the rate should immediately index the exemption to the inflation rate. If the inflation of the last 10 years continues over the next, the $1 million exemption will be worth a third less. Why should the government get rich by mismanaging the monetary system?
In accord with standards of justice and American tradition, the tax ought to be repealed completely. History provides a guide to how to proceed. America’s first experience with inheritance taxation helped to spark the American Revolution. In 1765 the British Parliament imposed a stamp tax on the colonies, which covered newspapers, bills, receipts, college diplomas, and all legal documents including wills.
Americans hated the stamp tax and refused to pay it. Tax collectors were set upon by rioting mobs, and the tax was quickly repealed. This experience radicalized future revolutionaries like Patrick Henry, who decried any taxation without representation.
But the lesson did not stick. John Adams, second president of the United States, brought the stamp tax back in 1797 along with taxes on housing, land, and slaves. These taxes, plus Adams’s support of the draconian Alien and Sedition Acts, galvanized Thomas Jefferson and the Republican party. The “revolution of 1800” swept Adams’s party out of power and brought Jefferson to the presidency. Adams had increased taxes so he could raise a military to combat French shipping attacks. Jefferson’s isolationist policies, on the other hand, allowed him to cut expenditures, reduce the debt, and abolish all internal taxes in 1802 (except the salt tax, which was abolished in 1807).
For the next hundred years, inheritance taxes appeared only in wartime, and were repealed at war’s end. This began to change in our own century. President Theodore Roosevelt made the inheritance tax a federal issue with his “muckraking” speech of 1906. He called for inheritance taxes on those fortunes “swollen beyond all healthy limits.” His justification was not to raise revenue but to appease the radicals and preserve “equality of opportunity.”
The estate tax grew in fits and starts, and today it is justified, not as a revenue raiser, but as a curb on the desires of families to pass on their property to heirs. With a basic exemption of $600,000 and a top rate of 55 percent, it is a tax on cash and bank accounts, stocks, bonds, real estate, businesses, equipment and machinery, automobiles and other property, life insurance policies, artwork, even personal belongings. In short, it’s an everything tax.
Calculating the tax requires that the deceased’s property be taxed at so-called fair market value. In practice, this means that the deceased’s estate agent must battle on behalf of the heirs with the IRS. The IRS pushes for higher valuations on difficult-to-value property like businesses and personal belongings in order to extract more revenue.
Among the biggest economic costs of the inheritance tax is the loss of savings. The tax changes the behavior of the bequestor. Imagine a man who wants to pass on an estate of $1 million to his son. Without a tax, he must save $1 million. With a 50 percent tax, he must save $2 million.
Will he do it? That depends on how much he is willing to sacrifice, in terms of time and resources, to accumulate a large bequest for his son. The higher the inheritance tax, the more likely people are to stop saving for the long term and start consuming now. The desire to give bequests decreases when wealth decreases. Inheritance taxes decrease wealth, and thus reduce both the desire and the ability to pass it along to the next generation.
Economists used to understand this. Adam Smith and David Ricardo saw inheritance as a key incentive for saving. Alfred Marshall held that “family affection is the main motive for saving.” Josef Schumpeter called the “family motive” the “mainspring” of savings. F.W. Taussig argued that, for long-term savings, “the main motives are domestic affection and family ambition.” Frank A. Fetter argued that “Much of the existing wealth probably never would have been created if men did not have [the] right of gift.”
Then, in the 1950s, economists began to change their minds. They came to believe that the bequest motive has little to do with saving and capital accumulation. They began to argue, contrary to evidence, that savings decisions take place over the course of a lifetime instead of generations.
In fact, family fortunes are typically the accumulated savings of several generations. This allows for what Frank Taussig called “sustained accumulation and permanent investment.” This has become more obvious in the last decades, as savings rates have plunged, and as families have had to sell businesses, land, and art treasures to pay the tax.
Yet, in recent days, as the pro-repeal lobby gains a foothold, the cry of fairness and justice is heard in opposition. The moral critique of bequests has rarely diverged from the arguments of Andrew Carnegie at the turn of the century. Though one of America’s richest men, he campaigned vigorously for the estate tax in a series of influential articles in the North American Review
First, Carnegie argued that a man’s wealth should go to the community (from whence it came) on his death. But by equating the community and the state, Carnegie tragically worked to deprive others of the opportunity to be as generous as himself. Throughout North America one can find hundreds of libraries and public works testifying to Carnegie’s generosity and the sincerity of his beliefs. Had Carnegie faced an estate tax of his own devising, his estate would have flowed into the anonymous coffers of the government never to be seen again.
Second, Carnegie argued that inheritance is a burden on children because “it deadens the talents” and “tempts” the heir to “lead a less useful and less worthy life.” We are all familiar with famous heirs who led worthless and parasitical lives. They are a staple of biographies because the contrast between the virtues of the founding generation and the vices of the heirs is so stark.
The adage says that wealth corrupts; perhaps, but wealth has no monopoly in this regard. It is easy enough to lead a worthless and parasitical life without an inheritance. Why should an inheritance increase this possibility? Indeed, reason suggests the opposite. Those who are able to bequeath a material inheritance are also often able to bequeath a sound moral and educational inheritance.
Economists and other writers often ethically rationalize the estate and inheritance taxes by appealing to the principle of equality of opportunity. Surprisingly, this appeal is prevalent among some classical liberal writers (even more so than among writers of a more leftist bent).
Nobel Laureate James Buchanan, a conservative economist, for example, argues that a guarantee of (”some”) equality of opportunity is “inherent in the political philosophy of the free society.” Self-described libertarian Irwin M. Stelzer invokes the phrase in the defense of “a draconian inheritance tax.”
The idea of “equality of opportunity” appears just. The intelligent child of the inner city who is unable to excel because he lacks a good education is contrasted with the luckier child of the suburb. Why should forces for which the child is not responsible and does not control be such a large factor in his life? Why are otherwise identical individuals placed in such differing circumstances?
But these scenarios are compelling because they show lack of opportunity itself. Equality of opportunity could be brought about by ruining the schools for everyone. Only the spiteful and envious could prefer such a situation to that reigning when the children were unequal. Taxing the rich does not improve the lot of the poor.
“Equality of opportunity” also sounds better when contrasted with equality of condition or outcome. In fact, equality of opportunity is nothing but equality of outcome applied at the beginning of life rather than throughout life. Both forms of equality are coercive and totalitarian. Taken seriously, equality of opportunity requires that all inheritance—monetary, genetic, and experiential—be abolished.
So long as parents care for their children, the primary means of transferring money through the generations will be through inheritance. It benefits bequestor and heir, strengthens family ties, and increases long-term savings. When the state intervenes in this process it increases its coffers at the expense of the smooth operation of family, society, and economy.
Alexander Tabarrok is Research Director at the Independent Institute
