It’s Time to Replace the Estate Tax With a Progressive Inheritance Tax

Walmart workers and their supporters shut down Park Avenue in front of Alice Walton's penthouse in New York to protest Walmart's low-wage model, October 16, 2014. The six heirs to the Walton family fortune have more wealth than the bottom 42 percent of Americans combined.Walmart workers and their supporters shut down Park Avenue in front of Alice Walton’s penthouse in New York to protest Walmart’s low-wage model, October 16, 2014. The six heirs to the Walton family fortune have more wealth than the bottom 42 percent of Americans combined. (Photo: UFCW International Union / Flickr)

Large amounts of inherited wealth, and gross concentrations of wealth, inherited or not, characterize aristocratic, not free and democratic societies. We can and should use the tax system to support broad-based economic and political opportunity and substantially reduce dynastic wealth.

Inheritance is an important driver of the huge and growing wealth disparities. Gratuitous gifts and bequests represent between 35 and 45 percent of household net worth. This estimate is based on surveys where respondents are asked whether they have received any inheritances, gifts or other types of wealth transfers, such as trust funds, in the past and the value of the transfer. This method is likely to result in substantial under-reporting. Inheritances as a fraction of total wealth, especially of the largest fortunes, are likely to be much more than we will know.

We tax these wealth transfers through our estate tax, raising less than $12 billion, or just 1 percent of the $1.2 trillion transferred annually. Many people who receive such vast amounts of wealth through inheritance have no need to ever work or do anything of value to society. They can live off the investment proceeds of their inherited wealth at an income far greater than that of the majority of the full-time working population.

Six of the 10 wealthiest Americans are heirs to major fortunes. The six Walmart heirs have more wealth than the bottom 42 percent — or 132 million Americans combined. We are at the beginning of the largest intergenerational transfer of wealth in history. A Boston College Center on Wealth and Philanthropy study projects that $36 trillion will be passed down to heirs from 2011 to 2016. This will create a new aristocracy with unprecedented wealth and therefore, power.

Societal Contribution and Economic Reward Must Be Correlated

For economic inequalities to be tolerable, they need to be, to the degree practical, associated with merit or contributions to society and be within reasonable bounds. Inequalities must be useful to all and only then can they be justified. (An important Enlightenment ideal was “Social distinctions can be based only on common utility,” according to Article 1 of the 1789 Declaration of the Rights of Man and of the Citizen.)

The advantages that vast intergenerational wealth transfers provide are based not on merit, but on luck. Clearly, public funds are needed and should be raised by taxing inherited income, especially large amounts, at a higher rate than earned income. Also, taxing bequests and gifts more heavily than other income will limit or reduce dynastic wealth, a purpose of value in itself, in addition to the value created by a large increase in public resources. Society can direct these resources to purposes that will maximize benefit to all. Also, this tax can be paid by people more easily able to bear the burdens of government finance. It will provide funds sufficient to support free college education and substantially increase the funding of relatively low-funded K-12 schools.

“A Just Man Will Rejoice” in Excessive Wealth Being Returned to Society

In Agrarian Justice, Thomas Paine, one of the most widely respected political theorists, offered an estate tax proposal as a remedy to economic injustice in the old Europe of his day. He justified it by pointing out that as hunter-gatherers, or for the vast majority of human existence, we all were equal inheritors of the Earth:

It is a position not to be controverted that the earth, in its natural uncultivated state was, and ever would have continued to be, the common property of the human race. In that state every man would have been born to property. He would have been a joint life proprietor with the rest in the property of the soil, and in all its natural productions, vegetable and animal.

Paine believed that civilization should provide advantages to everyone and that a person in poverty or with no wealth is in a worse state “than he would have been had he been born in a state of nature, and that civilization ought to have made, and ought still to make, provision for that purpose [of providing everyone the value of their lost natural inheritance], it can only be done by subtracting from property a portion equal in value to the natural inheritance it has absorbed” from other people, to be provided in compensation to them.

He proposed an estate tax to accomplish this, using the funds generated to provide everyone at age 21 sufficient wealth to start a farm to earn a livelihood and a pension sufficient for a decent livelihood starting from age 50, and to support those with disabilities. He chose to tax wealth upon death for these purposes:

[B]ecause it will be the least troublesome and the most effectual, and also because the subtraction will be made at a time that best admits it [since it] is at the moment that property is passing by the death of one person to the possession of another. In this case, the bequeather gives nothing: the receiver pays nothing. The only matter to him is, that the monopoly of natural inheritance, to which there never was a right, begins to cease in his person. A generous man would not wish it to continue, and a just man will rejoice to see it abolished.

A Tax to Enhance the Productive Capacity of the Following Generation

Rather than acting on Paine’s vision of everyone starting adulthood with wealth sufficient to begin a productive life, today we force many young people to start adulthood with mountains of student loan debt from under which many will never dig out. We should act on Paine’s vision for young adults in a way appropriate for our times. In Paine’s time, acquiring what was necessary to farm was the main way to earn a living. Today, knowledge acquisition is most important, so society should offer resources for this purpose and provide it, as Paine likely would, using a tax on wealth transfers at death.

The major contribution that knowledge makes to wealth creation today, unlike in Paine’s time (although it was important then also), is indicated by our productivity being 30 times larger. This increase is the result of accumulated knowledge. To use much of modern society’s large accumulation of inherited knowledge and advance it to further improve our capacity to create wealth requires widespread knowledge acquisition. Society should now facilitate this with free access to post-secondary education that a just and beneficial inheritance tax can easily support.

The Proposed Inheritance Tax

To reduce the growing economic divide and increase opportunity for all, we should replace the estate tax with an inheritance tax that taxes inheritance as income, with a $300,000 exemption using more progressive income tax rates plus 5 percent, except for incomes $50,000 or less which are taxed at 0 percent. Below is a table defining the marginal tax rates (based on more progressive income tax rates I propose elsewhere).

$ in inheritance above $300,000 Marginal tax rate
$410,000+ 60%
$260,000 – $410,000 55%
$160,000 – $260,000 45%
$90,000 – $160,000 25%
$50,000 – $90,000 15%
$40,000 – $50,000 0%
$30,000 – $40,000 0%
$20,000 – $30,000 0%
$10,000 – $20,000 0%

An estate tax taxes the donor, which is inappropriate, and taxing the donor has allowed this tax to be denigrated with the term “death tax,” even though it is essentially a tax on the living heirs. The “death tax” label also implies that everyone who dies has to pay the tax, but under current law, only 0.14 percent of estates owed the tax in 2013. Inherited wealth should be taxed more appropriately, based on each heir’s ability to pay using a progressive inheritance tax on the heirs.

In the past, the failure of estate tax supporters to address what exceptions should be made for family farms and family-owned businesses was a prime reason for the success of estate tax opponents. Most people consider that forcing the sale of a farm or business to pay the tax is unjust because sometimes it could disrupt the heirs’ lives. However, this concern is unjustified for our current estate tax. Only a handful of family farms and businesses owe any estate tax at all, and virtually none have had to be liquidated to pay the tax.

The inheritance tax will yield $253 billion or $241 billion more per year than the estate tax it will replace (assuming an average bequest is to five heirs).[1] This tax satisfies the total funding requirements for free college education based on eliminating 10 percent more than the total tuition being paid by all public college students in 2013, or $138 billion, and the following federal education expenses, and will be “earmarked” or devoted exclusively for these purposes to make the benefits of this policy more obvious.

Poorly Funded K-12 Schools Need More Financial Support

There continue to be many underperforming schools and international comparisons indicate far more needs to be done to assist schools in low-income neighborhoods, where the property taxes that are a large source of funding for schools are inadequate. In contrast to European and Asian nations, which fund schools centrally and equally, the wealthiest US school districts spend nearly 10 times more than the poorest and spending ratios of three to one are common within states.[2]

Of the 1.8 million high school graduates who took the ACT test in 2013, only 26 percent reached the college readiness benchmarks in all basic subjects.Only 5 percent of Americans ages 25 to 34 whose parents didn’t finish high school have a college degree. The average across the 20 rich countries of an OECD [Organization for Economic Co-operation and Development] study is 23 percent. Both unequal access to good quality K-12 education because of the huge funding disparities, and huge financial barriers to a college education are mainly responsible for this enormous and ominous international disparity.

Thirty years ago, the average gap on SAT-type tests between children of families in the richest and poorest 10 percent of Americans was about 90 points on an 800-point scale. In 2014 it was 125 points, one of the worst gaps in the 65 countries participating in the Program for International Student Assessment.[3]

In addition to reversing our nation’s decline in the educational status of our citizenry and ensuring a well-educated citizenry through free college education, this tax will enable us to provide an additional $90 billion to relatively poorly funded K-12 school districts. Since the proposed inheritance tax raises $241 billion more per year than the estate tax it will replace, we would have $103 left over after the $138 billion needed to support free college education.

For the reasons described later in the paragraph, $90 billion seemed to me a reasonable increased allotment. If this much is not needed, it would not be spent. The $90 billion is not a result of a detailed analysis of the needs. This will help us ensure that every child receives an education that prepares him or her for success in college, careers and life. We spent $621 billion in 2011-12 on public education in total at all levels of government. Considering per-student spending disparities as large as 10 to one between some school districts, and the inadequacy of the $51 billion total federal spending under the No Child Left Behind Act and Elementary and Secondary Education Act in eliminating education quality disparities,$90 billion could be well used to raise the quality of education in our lower-funded schools.

The total additional expenditures budgeted for K-12 education and the $138 billion expense for free college education, is $228 billion, which the revenue from this inheritance tax will satisfy, with $13 billion remaining for other purposes.

For more information, see: www.newenlightenment.us.

Footnotes:

1. My calculations use the Federal Reserve Board’s Survey of Consumer Finances complete dataset, the only fully representative source of information on the broad financial circumstances of US households.

2. From “Educational Quality and Equality: What It Will Take to Leave No Child Behind” by Linda Darling-Hammond, in All Things Being Equal: Instigating Opportunity in an Inequitable Time, edited by Brian D. Smedley and Alan Jenkins.

3. From Saving Capitalism: For the Many, Not the Few, by Robert Reich, pg. 140.

© Robert Bivona. May not be reprinted without permission from the author.