An Argument to Abolish The Federal Estate Tax
By Scott Currey
J.D., University of the Pacific,
McGeorge School of Law to be conferred May 2005
In 2001 Congress temporarily repealed the federal estate and gift tax, phasing it out by 2010, only to see it reinstated the following year under a "sunset" provision, if Congress fails to enact a permanent repeal. For opponents of the tax, this ephemeral and uncertain status represents a Pyrrhic victory. The time has come for the complete and permanent abolition of this vestige of socialist ideology. To the extent it might ever have served a purpose, a premise I would reject, it has no place in America today. Whatever historical premises might appear to legitimize it, mere custom and tradition are no reasons by themselves to continue indefensible policies by themselves, and find support only for those reasons. Whatever might be said about the history of estate taxation, it is not the American tradition, and was not the practice for most of our history.
First, it has never been clear to me how the estate tax is constitutionally permissible, since the 16th amendment authorizes only taxation on income, and the federal estate tax in no way resembles any sort of income tax in its operation. If not a tax on income it cannot be sustained as a wealth or property tax since the Federal constitution has no authority to do either. It differs from an inheritance tax, which is paid by recipients (devisees), and this tax can be regarded as income. Yet, since no court has so found, it is probably a moot point. The Supreme Court rejected constitutional challenges holding that the estate tax is an excise tax on the "privilege" of transferring wealth at death. While the rationale of the court is beyond the scope of this article and the issue appears to be settled, it is worth addressing a few points to the holding. First, it implies that the right to transfer property, generally regarded as one stick in the bundle of rights associated with ownership, is merely a privilege, meaning all property "rights" are merely privileges. Also, the court seems to have abandoned the historic distinction between direct and indirect taxation, such as excises, a distinction the founders certainly had in mind when including the pertinent clause in Article I of the Constitution proscribing direct taxes except as apportioned among the several States. The 16th amendment changes this provision applied only to income taxes, which excise taxes are not. As an excise tax, however, which is generally upon goods without discrimination based on individual characteristics (i.e. state sales taxes), the estate tax application is grossly inequitable and arbitrary. It is a direct tax in any way the term was historically understood. This rationale could justify any manner of direct Federal taxation of property. Nevertheless, given such precedent, this article focuses on the numerous other problems with the tax, political and economic questions as well as justice and equity, the latter being an area courts have abdicated in the area of taxation.
Historically, taxation of generational wealth transfers has always been around in some form. This says only that the egalitarian ideals are not new. Indeed, the socialistic ideology goes at least as far back as Plato. As far as relevant American history, despite some affinity with egalitarian principles among early Americans, it was unthinkable to the founders that the federal government would be vested with a power as to directly tax property in any form. Proponents of estate taxation often quote Jefferson, for example, as a justification; "The Earth belongs to the living in usufruct." To understand Jefferson however, is to recognize the manner in which he uses larger ideas to convey abstract notions. Taken in context, he was not referring to tangible property, which would be quite hypocritical considering his wealth. Likely he meant the Constitution and the problems of governance it was designed to address at the time.
Adam smith suggested taxing inherited property at varying rates depending on the degree of relation to the decedent, and early economists such as utilitarian John Stuart Mill thought such a tax would encourage productive endeavors among heirs of large fortunes. Yet it is worth noting that Adam Smith suggested the children and those otherwise dependent should not be taxed and that the tax should not exceed about seven percent. Rates currently are 55 percent and have been as high as 77 percent historically.
Mill further proposed an extensive system of property taxation depending of the nature of use. The least productive land should be taxed more to discourage idleness. One problem with the theory is that it is presumptive and paternalistic to declare that different enterprises or uses of land be subject to different standards of treatment under the law. This seems incompatible with the view that property or estate taxation should be based on the assumption the inheritance is necessarily unproductive without taking into account the individual devisee's intended use and productive capacity. Furthermore, decreasing taxation of land depending on how much it produces would tend to encourage over-production. Modernly, society increasingly sees over-production associated with problems such as environmental degradation and destabilization in agriculture due to lower prices. In fact, current tax policies often favor preservation of natural habitat and conservation through various exceptions. National agriculture policies have encouraged decreased production to raise prices since the 1937's.
By analogy to Mill's proposed system of property taxation, the premise "productive enterprises must always be encouraged" presents additional problems. First, as indicated above, defining production can vary from person to person and by society over time. Would it be appropriate public policy to discourage one, who had the means to do so, to be more concerned about preserving his property as a natural habitat, or in selling his development rights, because he values the preservation of his lands in a natural state as a higher end use than conventional agriculture or development. There is considerable debate today, for example, as to organic (higher social utility) vs. conventional farming (a higher return on capital) and whether the trade-offs, if they exist, should be balanced, and if government should play a role in achieving such a balance, or should merely set the rules of the game.
Thus, in addition to uses of land and other forms of property by analogy, people also engage in various occupations and avocations that vary considerably in societal perceptions of value. The extent that indolent heirs should be encouraged to be productive, will be examined below. I shall address the issue of the real harm to society these heirs and their large accumulations of wealth really present. But first, I shall address the logical fallacy inherent in the argument for the estate tax with its arbitrary definitions of "wealth" and other distinctions.
The only just application of the tax would be the politically unpalatable expansion of the tax to all property of all persons upon their death. In this way it might be defensible because everyone would be subject to it and it would be consistent with the principles of the social contract, as well as the Constitution, as all would be treated equally under the law. Tax policy has never been held to such a rigorous standard because it requires only a rational relationship to a governmental purpose. I believe the principle which distinguishes rational basis from strict scrutiny is merely an accident of history, and not logical per se. Who would reasonably claim any aspect of our tax code is rational? Extending the estate tax to all property held at death might seem absurd to all but the most ardent socialist would be and politically untenable, as people would quickly discern its ruinous and oppressive nature. Most defenders of the tax now recognize the oppressive burden placed upon small businesses and farms and call for raising the estate exemption; or what seems worse as far as fairness is concerned, to carve out special provisions for the most nostalgic and sympathetic classes of estates. As pragmatic relief for farms, small businesses, and families, this change would preserve the tax, and continue to generate revenue while protecting the collectivist ideology of the defenders of the tax itself.
Larger philosophical questions as to the whether inheritance taxes should be allowed at all are well beyond the scope of this article, and aren't relevant as they are not at issue. Opponents of the repeal don't make this argument. Rights of inheritance are recognized under law as another stick in the bundle of property rights and such questions of taxation should be assessed in the context of property rights generally, applying the same standards to all persons and all like kinds of property. Estates belong to the devisors, who are in possession when they direct the distribution of their property, so to the extent that one questions the right of inheritance in receiving a gift; certainly the right to devise is far more fundamental. But unlike inheritance taxes paid by recipients according to the amount received, the estate tax makes no distinction between estates passing entirely to a single person or those divided among many heirs. Since the proponent's primary argument revolves around the concentration of wealth, it seems the tax should be directed to prevent such concentration by inheritance, not when dissipated among many.
The argument to raise the exemption is to protect more modest estates such as farms and small businesses (those increasingly less likely to be regarded as "super rich"). However, the targeted nature of the tax is its most egregious injustice, and could be defended only by a more equitable and generally application. Raising the exemption to protect most hard cases, only exacerbates the inequitable and confiscatory application. The tax as it is currently structured exempts all but a few families (around one percent). The tax can be easily imposed because so few are subjected to it; their numbers never accounting for more than an insignificant part of the electorate. The more narrowly one applies a tax, the fewer who actually pay it, and the more acute is the violation of the principle of equality under the law. Thus, it represents a form of popular tyranny, confiscating property and undermining the rights of a minority group. Aren't the wealthiest Americans a minority group subject to legal protection? Though this "plight" of the wealthy is not likely to elicit strong emotional sympathies, it is true that any person in America is subject to protections of his liberty, the wealthy included, even though they constitute far less than a majority of the people.
Proponents of the estate tax (or opponents of its elimination) may find cause for support on the grounds that it does not target a particular group or is not unequal because all are indeed subject to it because everyone could possibly be wealthy. A majority could, therefore, agree to impose the tax because all could find themselves in a situation in which they are wealthy enough to be subjected to it, just as one consents to laws against murder knowing that he could be subjected to punishment were he to be caught committing murder.
This preceding argument might be better directed toward criticism of taxation itself, but its fallacy as a response to criticism of the estate tax is that it ignores due process. Consider laws against murder, where people can consent to the abolition of a jury trial, the right to counsel, or other constitutional protections. Would the logic still follow that since all could be accused of murder, such popular consent would justify these actions in all cases? What about an example of a homeless policy instituted by majority consent of the people? The majority determines such policies are appropriate simply because it is what the majority of the people want and recognize that because they could be homeless too, they implicitly agree to endure the same treatment if ever in such a condition. That few believe they actually will suffer homelessness is irrelevant with respect to the social contract. Those who think they will never be in such a condition implicitly consent to different and arbitrary standards of law, because they believe they are fundamentally different and immune to the greatest hardship and privation. This is the antithesis of the social contract.
Many now may favor some type of reform of the estate tax, but criticize its complete elimination as a windfall for billionaires. We hear critics of a repeal invoke Bill Gates' escape of taxation. What if the government were to tax only the estate of Bill Gates and no one else? It could do so by simply raising the exemption high enough so only he would have to pay it. No one would seriously support singling out any citizen to be bound by a law and no one else. It is as unjust for one as well as for a small minority of persons.
Opponents of the repeal including Bill Gates, Warren Buffet, and other billionaires have recently said the policy would foster a class of indolent, profligate, "aristocratic" heirs. Why then tax only some of the estate and not confiscate them entirely, if one must "earn" all he or she has? These billionaires have every right to do as they wish with their resources, to give to charity rather than their own children, but what business is it of theirs however, to impose their peculiar values on other families? Some people may dispose of their wealth in ways these prominent citizens view as admirable, while others may not.
The greatness of the free market is that it renders precisely the kind of justice the billionaires advocate, and far better than any person can fairly determine. If the heirs are responsible, the assets will be put to productive, efficient uses, creating jobs and economic opportunities for many, or doing great good for society, in which case the "right" people will control the capital. If, however, they are profligate and irresponsible, the assets will be squandered, and the "wasted" money will find it's way soon enough into the hands of those more industrious. Most importantly, why should society concern itself with indolent citizens with the means to support themselves, freeing the public dole of that responsibility? Furthermore, do these billionaires suggest that one should not have a choice to live a leisurely life if he can, that everyone must work, each according to his ability, and from each according to his means? What would they say about early retirement for those who successfully plan for it? As for their other criticisms of the repeal, that charitable donations will decrease since the estate tax encourages such activities, there is no empirical evidence can sufficiently demonstrate this result. Actually, since the increased role of government in welfare has in fact lessened the burden of charity for the general population it could just as assuredly be the case that welfare programs have absolved the people of this responsibility, but only with greater inefficiency and paid for through arbitrary taxation.
I have no doubt that past injustices of institutional and de facto oppression constituted great obstacles to achievement, and plague us still. The roots of this can be traced to Rousseau, who believed that laws and institutions, of which property was central, were merely tools or "rules of the game" devised by the strong and cunning to protect their gains and established positions in society. This was another form of anarchy as there are two kinds of inequality, natural and institutional. Notwithstanding the troubled legacy of stability inherent in Rousseau's radical and revolutionary thinking, this view survives today in many forms, and underscores modern socialist theories to which growing income and wealth inequality is central (though the distinction is often forgotten). The large accumulations of individual wealth today serve as the manifestation of this continuing or growing trend, according to those who ascribe to this view. The question now is not to debate the past. I ask what we should do as a remedy. Only through due process can injustices, where they have occurred, be justly compensated. Programs to assist the disadvantaged that do not undermine the liberty of anyone else are political questions of how much should be done, so long as revenue to support programs is collected in a way consistent with the principles. That injustice has occurred is merely further evidence of the necessity of protections of liberty from a capricious popular will.
Wealth distribution today in the U.S. is said to be as large as it has been since the gilded age. Without questioning the dubious statistical methods used to posit this notion, the distribution simply is not the greatest it has even been. This occurred during the colonial and post-revolutionary period prior to the industrial revolution that is commonly deemed the cause of extreme and obscene inequality. The idyll of the yeoman farmer and the nostalgia of the agrarian republic so revered by egalitarians was not so idyllic as it seems. One must thus look elsewhere for the model egalitarian society.
Looking to contemporary societies is equally elusive. Economists measure wealth inequality by the Gini coefficient, which calculates as a co-efficient the percentage of national wealth of each percentile of the population. While some socialist countries are slightly lower (more equal) than the U.S., another blatantly communistic country is roughly equal to us. In fact in 2001, the U.S and China had precisely identical Gini ratios (40.1) according to the World Bank. This fact says more about the inherent problem with these kinds of statistics than anything about the economies of the two countries. It demonstrates the limits of bureaucratic social engineering are targeting appropriate levels of capital accumulation and distribution.
While the estate tax is devastating to small estates only slightly above the threshold, but certainly not mass fortunes, the tax does nothing to encourage industriousness among the heirs of substantial estates who are the biggest concern. Even 100 million dollar estates, taxed at 55 percent would not likely have much of an effect on the motivation of an heir who still receives 45 million dollars. The necessary conclusion is that at some level society must decide what is too much, beyond which there is no incentive to work. This presumes is it the business of government to mandate everyone work to a "sufficient" degree. Would this mean early retirements would be forbidden? Any such decision is so arbitrary that this argument lacks any rational justification, and would be largely ineffectual for the primarily purpose of encouraging industriousness.
Moreover what is the harm associated with large accumulations of wealth.? One issue is that indolent heirs won't work. What is the harm to society in their wealth is squandered? Only if they set fire to it or bury it in the ground would it impact the economy adversely. The faster one squanders his assets the faster it's the channeled to more productive capacities. If one can live his entire life, and never run out of money, this means only that despite his profligate "waste," the waster will not rely on the state to support him. Many in society are equally unproductive but without their own resources to support themselves.
If, however, concentrations of inherited wealth grow progressively larger, this suggests productive investments with associated societal benefits. Further, what we call waste often is the preference of eccentrics resulting in accidental discoveries. Often the arts can exist only with large benefactors. New goods on the market are purchased first by those with money to spend as such goods are often of questionable utility until they become more widespread through lower prices. Finally, I propose that eliminating the estate tax is not to eliminate taxation of transfers of property entirely but to restrict it to only reasonable, equitable rates consistent with the general approach to taxing increases on capital economists agree is rightly regarded as income. This is done through the capital gains tax.
Opponents of the repeal argue that rather than the estate tax being a gratuitous tax on previously taxed income, estates are never taxed and are simply passed along to successive generations perpetuating wealth and privilege, ever-increasing in value as they are passed along into perpetuity, the capital gains of these being a source of income to the untaxed descendants. This argument is equally spurious because it also ignores basic equality. To be consistent only the universal and uniform application of the tax with no one's assets exempted from it would render it equitable, because the process of determining which estates are characterized by such privilege is by definition arbitrary. I have yet to hear serious advocacy of this idea because it the antithetical to the principles of property itself. Historical precedents have firmly established the inalienable rights of property, which includes all rights associated with it, including inheritance of that belonging to one's parents. Do wives have a greater claim to the estates of deceased husbands than the children do? Spouses have unlimited estate tax exemption, but what is the logic in protecting a 30-year old trophy wife from taxes on the estate she inherited from her 90-year-old, recently deceased husband, while his own children, perhaps twice her age and actual blood relations, are taxed? Furthermore, the principles of community property are not based on common law, and should give way to the establishment of equal rights between wives and children. How should the tax treat a family whose generations are forty years, while another's is twenty? Would not the one pay twice the tax than the other in the same number of years passed? Thus it is not the estate, which is taxed, but rather one upon each death and truly represents a death tax in every sense.
The "never taxed" argument is also fallacious on economic grounds. Namely, because inheritances only become income when they are sold, in which case they are subject to capital gains taxes as are all assets no matter how they are acquired. It is true that inherited assets that are sold have a cost basis equal only to the value at the time they were acquired, thus the appreciation of assets held by preceding generations goes untaxed, but this is true with all assets which are passed on, whether they would fall under the statutory estate tax or not. It clearly can only be equitable if all such assets are treated the same way with or without a gratuitous estate tax.* If inheritances do constitute untaxed income, what claim does the government have to it on this reason alone? There are many other kinds of income according to tax economists like Haig and Simmons' definition, which most would consider quite absurd to tax. Billions in unrealized capital gains go untaxed every year in the appreciation of unsold property.
Nevertheless, some ardent defenders of the estate tax incredulously maintain that it is only symbolic and that the affluent do not pay taxes anyway, that the effect of the tax is over-dramatized. This proves too much. What this ultimately means, if true, is it is precisely the least able to avoid it, those estates of the most limited means, the least sophisticated and unable to hired the armies of lawyers to minimize the effect of the tax who are most affected by it. It is these people that even defenders of the tax agree should be spared. The wealthy, they claim, can afford to take advantage of loopholes, which pervade throughout the code due to their influence in government. This argument is so absurd that it hardly deserves a response, except to point out the inherent contradictions in the argument of the great revenue loss associated with the elimination of the tax. How can revenue loss be so great if the tax is easily avoided? Furthermore, such loopholes are precisely the kind of inequity that is so reprehensible about our tax code. What is the use of a tax in which "nobody really pays"?
This leads to the argument more prominent now under the recent actual and projected budget deficits: How can we afford a repeal under the current fiscal circumstances? First the tax repeal is scheduled for 2010, and a permanent repeal would apply to subsequent years -- too far afield to fully assess the fiscal impact. The tax will continue to generate revenue for the immediate future as the fiscal crisis looms, and while the vast wealth increases in society, should do so even at decreasing rates, and increasing exemptions. Second, the estate tax has never been a significant revenue producer, and this is conceded by its advocates as not being the primary objective. The estate tax has never generated more than one or two percent of total federal revenue. A wider application, as suggested above, would also generate far greater revenue, perhaps even substantially lower rates, as owners of very large estates would have less incentive to subject their heirs to the burdens associated with reducing tax liability, such as charitable trusts, etc. People are more willing to pay taxes at lower rates because the opportunity of cost avoidance can be significant. While the degree of change in revenue due to change in structure and rates is an analysis far beyond this article, this kind of dynamic analysis should be taken into account where relevant. What is certain is that the loss would be less than projected by forecasting proposed changes in rates over anticipated amount of assets passing at death.
The theoretical foundations of consent and legitimacy of government and its policies is the basis of the social contract. We consent to laws, and are all equal under such laws. Taxation, like all laws, must have the consent of the people who it affects; or those who pay in the case of taxes. Does the popular will as determined by a majority of the persons in society, give consent, merely too be taxed and say nothing more, leaving the sovereign the discretion to implement it? Should the consent be more restrictive and narrowly defined as to the ways and means? To grant merely the power to tax will put no limits on the degree and would bring us back to the Hobbesian tyranny, or the other extreme, the majoritarian absolutism prescribed by Rousseau. Consent does extend not only to the question of legitimacy in who rules and how they come to power, but also how they rule; the process defined by law. The Declaration of Independence says, ".that to secure these Rights, Governments are instituted among Men, deriving their just Powers from the consent of the governed." Not simply deriving powers from consent, but only their just powers, and it should never possess unlimited power even with consent. The two kinds of legitimacy are who the sovereign is, and how he came to be so, or the process, and what powers it should be vested with. The former without the later is tyranny.
Recent developments in the direction of tax policy indicate positive changes in the future. Public policy seems to be shifting toward more sensible tax policies, as there is open discussion about a national sales tax, and a uniform (flat) income tax. As a recent poll shows, 60 percent of Americans are against the estate tax. Despite these trends, no progress is possible without ending the unprincipled and inequitable death tax on estates, a most obvious and conspicuous offense to liberty. It is the epitome of the hypocrisy of the people who claim devotion to liberty and the Constitution to offer elaborate prescriptions for the ordering of society according to their values, redefining long-held understandings of these concepts to conform with their ideology. For the socialists, the estate tax is the last vestige of their repudiated utopian dreams, one they will fight most assiduously to preserve.
* The capital gains tax is in effect an estate tax it this context, but would be fair and equitable, paid by all and only when the value of an asset is realized. The effect of actual purchasing power of higher wealth is thus captured.