Do We Need an Estate Tax, and that aside, Is the Estate Tax Fair?
What is the Estate Tax?
The federal estate tax is a tax of 40% on every dollar over $5.49 million (or effectively $10.98 million per married couple) in 2017 dollars. That means it only applies to roughly .02% of families in the U.S. (according to the center on Budget and Policy Priorities) in its current form.
That means one could claim a $10.98 million estate (passed down by a family) and pay no taxes, but every dollar claimed after $10.98 million would be subject to the 40% estate tax.
TIP: One can put money in a philanthropic organization or company and then transfer control to dependents. This is one way to transfer wealth without it being subject to an estate tax. The ideal estate tax seeks to give an opportunity to the richest and their families to invest in the economy to continue their wealth but aims to avoid financial hoarding by the descendants of those who once contributed to the economy as that isn’t very “fair” to the 99.99%.
FACT: According to the Tax Policy Center 99.8% of estates owe no estate tax at all (and conversely 0.2% do). Of those who owe the estate tax: The top 10% of income earners pay nearly 90% of the tax, with over one-fourth of that paid by the richest 0.1%. Few farms or family businesses pay the estate tax (about 80 total in 2017).
Is the Estate Tax Fair?
Opponents of the estate tax (or “death tax”), a tax on large estates that only 0.2% of families pays, point to it as being unfair for a few reasons.
On reason is that the state has no right to “double tax” an estate (once upon claiming the wealth, and once upon death).
However, many wealth sources are “double taxed,” and those who pay the estate tax tend to make a lot of their income in capital gains (which are only taxed at 20% max), meaning that the total tax burden of a large estate is likely still less than the top federal income tax rate of 39.6% in most cases.
Another reason some say the estate tax is unfair because it hurts the 80 or so farms and small businesses who will pay this tax in 2017 (with some falsely claiming that the estate tax consumes nearly half of an estate’s value; that is a myth, the average effective rate is 17% and only very large estates tend to pay that much due to deductions, exemptions, and loopholes).
While the point about the farmers and small businesses just above the deduction limit is a strong point in general, it is still offset by the fact that the value of the farm or small business appreciated over time (thus the farm isn’t exactly being “double taxed”).
Ultimately, the estate tax may be unfair to a handful of family farms and small businesses valued at over $5.49 million (or effectively $10.98 million as a family) who don’t have the profits to pay the tax or exploit loopholes and deductions.
However, that handful aside, the estate tax is a fair tax in general, and also very necessary, as it helps account for the compounding of capital gains over time (and thus prevents a wealth gap).
Considerations on the Fairness of the Estate Tax
- Capital (like a farm or small business) can appreciate untaxed (at 0%) if a sale is never made, and if a sale is made, it is taxed at the long-term capital gains tax rate of 20% max. This means most capital was never taxed at the full 39.6% income tax rate in the first place.
- Taxable estates generally only pay about one-sixth of their value in tax (a 17% average effective tax rate after the full exemption amount, other deductions, and loopholes). In other words, these estates aren’t exactly getting “double taxed” in most cases. Consider: If the capital is amassed via a 20% capital gains tax, then it is taxed again at a 17% average rate on the estate, the total tax burden is about the same as the top federal income tax rate of 39.6% that ALL high income workers pay. This doesn’t factor in other taxes… but neither does the federal income tax.
- Only about 80 small business and small farm estates nationwide will actually face the estate tax in 2017, according to the Tax Policy Center.
- Even a farmer who has to sell the farm is still a multi-millionaire after the sale (so they aren’t poor or middle-class).
- There are a ton of loopholes and deductions the rich can take to avoid the current estate tax (this is actually unfair in general and should be reformed, as it unfairly helps the ultra rich and hurts the “small business” and farmer).
- A Trump, a Kushner, a Koch, or a Walton is not exactly in the same boat as the farmer. Their capital is real estate, corporations, and other capital investments that grow at 5% a year on average and compound. Plus, when these few wealthy families do pay taxes, they pay the 20% capital gains tax, not the full 39.6% income tax everyone else pays! In other words, if we abolish the estate tax like Trump suggests, the rich get a giant tax cut and will pay less in taxes than even the highest paid workers. That isn’t fair, but fairness isn’t the problem here, the problem is the wealth gap!
TIP: See the table below for how wealth compounds over generations and why it must be taxed to avoid an unsustainable wealth gap.
TIP: The estate tax is abolished by the 2017 proposed Trump Administration budget (meaning the budget proposes that the rate be ZERO). This will only grow the wealth gap in America and lead to more problems of money in politics and other aspects of oligarchy.
Fairness of the Tax Aside, The Estate Tax Helps Prevent an Oligarchy
Suffice to say, although the wealth tax may be unfair for a few farmers (who should be afforded an exemption), the estate tax is very fair to the people as a whole and the nation (as getting rid of the estate tax would increase the wealth gap, and an increasing wealth gap over time would most surely increase political, social, and economic inequality and pave the way for oligarchy).
This is to say, loopholes and specific cases aside (which illustrate some unfairness between the classes of the 0.2%), for the 99.98% of families who don’t pay the tax, and to the nation as a whole, the estate tax is rather fair in general (as it addresses not just income inequality in a year, but wealth inequality over generations).
Carnegie favors a progressive estate tax in his 1889’s Gospel of Wealth, in which he attempted to codify the responsibilities of the new rich.
Likewise, the main point of Thomas Piketty’s modern economic classic, Capital in the 21st Century, is to warn of the dangers of the wealth gap and to offer a small global estate tax as a solution.
The estate tax isn’t “a death tax” in this sense, it is rather an attempt to save our democracy from monied interests by preventing unstoppable intergenerational wealth. The rate of return on capital is higher than the rate of economic growth (with this being especially true since the 1980’s), and that means if we don’t tax capital assets handed down between generations (estates), then we risk wealth being concentrated into a small ruling class (an oligarchy).
This is to say, statistically speaking, the estate tax isn’t just fair, it is necessary. That doesn’t mean every aspect of the estate tax is always fair (consider a farmer who passes along their farm), but it does mean that it is necessary and reasonable in many cases (for example when the Waltons pass along their Walmart or the Trumps pass along their Trump empire).
The Big Picture: Raise the Estate Tax.
NOTE: Families can pass on double the individual amount using the marital deduction (so a husband and spouse can pass on up to $10.98 million and pay zero dollars in taxes in 2017 for example). Learn more about the Estate Tax from the Fool or learn how families can pass on more wealth from Ward and Smith. There are a few loopholes and deductions we don’t discuss in full on this page.
TIP: The general logic also applies to the gift tax and inheritance tax (a state-based estate tax). If there was no gift tax but an estate tax… then everyone would just give capital as gifts instead. These “death taxes” should be thought of together.
FACT: Only 1 in 500 estates is subject to the small estate tax.
TIP: This article is contingent on a general definition of fair that sees fair that sees fair as a utilitarian concept (“the fairest for all”). Feel free to provide counter-arguments in the comments.
FACT: The Estate Tax Provides Less than One Percent of Federal Revenue…. most of the nation’s income comes via federal income taxes, payroll taxes, corporate taxes, and excise taxes. Thus, while we argue an estate tax is vital and fair, it is only 1/100th of the the current picture. This page is about whether an estate tax is just, not about the current mechanics of our estate tax. We must be able to stop the oligarchy without punishing the farmer, only a fair estate tax can do this.
2015 Estate Tax and Annual Exclusion Tax.
The Estate Tax and Hoarding, the Velocity of Money, and Inflation/Deflation
Cutting some taxes on those who will spend and invest their money can have a range of positive effects on an economy and steady inflation. Cutting taxation on the excess wealth of the super rich which they are not investing, or using to build businesses, or even using to buy luxury items does not have the same effect. Instead, it can cause unwanted deflation or inflation depending on other specifics like fiscal or monetary policy.
This can be explained by the quantity of money theory equation: MV = PQ. The total money supply is M. V is the velocity of money or the number of times a single dollar is spent in a day. The combination represents how much money is in use in the economy each day. They both relate directly to the General Price level (P) and Quantity of goods and services produced (Q). In this equation, when people “hoard money” by “not paying an estate tax and other taxes” they “increase the money supply and decrease the velocity of money.” Thus, “Congress has to borrow money to avoid rapid deflation or inflation.” This leaves the FED only with the ability to “increase or decrease rates,” and they are already at “near zero.”
When the rich hoard money, everyone else suffers. Few things are more insufferable than going into debt because of a successful parent’s offspring. Going into debt for the parent is offset by their participation in the growing economy; and is thus “fair” in a sense. We are a nation which detests hereditary Kings, but we often ignore the vices of hereditary Barons.
Consider this example. A town has $100 to its name, 10 citizens, each of whom owns a shop with a fixed daily inventory of goods, and each of whom has $10. Every day each shop owner spends $10 by spending $1 in another shop. At the end of the day, each shop has $10. An economy runs on the base money supply plus the velocity of money such as this is predictable. Imagine that once a day a tourist comes in and brings $1, spending it at a random shop so that shop ends their day $1 up and spends that $1 the next day. The economy grows steadily, and the fixed amount of goods steadily increase in value. Since there will never be more goods, only their value can go up, not their quantity. Now imagine one shopkeeper manages to attract that new tourist’s business every day and starts saving the extra $1 for their heir. Now, instead of steady inflation, we have stagflation. There is no $1 a day growth of the economy although there is a $1 a day growth in money supply. Shopkeeper X is trying to save for their heir, but they are dragging down growth in the current economy by “hoarding” money that could have been circulating. Now imagine that shopkeeper saves so much that the town dips under its base $100 and has to start borrowing to offset the hoarding. The town now has debt which it must pay interest on, and inflation has set in. The money supply got larger, but the “velocity of money” circulating in the economy hasn’t increased due to that one shopkeeper saving the excess dollar whenever it gets to him. Continue this process, and over time it starts to get ridiculous. The whole town lands in debt. The cash that was hoarded far exceeds any cash-on-hand of the town. When the shopkeeper dies, the heir inherits all the money at once. That heir has the money needed to buy all of the town’s debt, collect interest, and have the capital to make future loans. Of course, nothing says the heir has to sell their shop business or not start the cycle again with their heir.
Yes, that is a simple example that doesn’t account for a range of paradoxical effects (see an essay on the velocity of money), but the gist is true. Hoarding money that needs to be in the economy to give a fortune to someone who isn’t contributing the economy is only good for the benefactor. It hurts everyone else, and the problem compounds over time. It is “unfair.” A fairer scenario would have been one where a part of the money was taxed and less money was saved. If people know they will be taxed more, they will save less. So in both cases, an estate tax would have provided useful incentives.
What is Velocity of Money? This video tells a different version of the story above, this time for “large corporate retailers hurt local economies.” Anything that “takes money out” of an economy has the same general effect.
The Estate Tax Like Other Taxes are Necessary Fiscal Policy
Over time economic slippery slopes, of which the estate tax related pitfall is just one of many, can lead to the political and economic inequality which has historically led to the rise and fall of nations.
We cannot maintain a system that does not tax out wealth back out and just borrows and creates debt. Thus, a “fair estate tax” is not only ultimately fair in general, but necessary.
The goal isn’t to punish those who do well; the goal is to avoid our nation’s wealth being tied up in some trust fund while the people suffer the effects of inflation and economic and political inequality over time.
A nation that values liberty and democracy must by extension have wise fiscal and monetary policy aimed at controlling the money supply and wealth gap over the short and long term.
The estate tax is an example of a tax that can effectively address the long term wealth gap, and as a bonus it doesn’t have that great an impact on individuals and their success in the short term.
Given the above, one could argue that any given nation would benefit from a fair estate tax that incentives real economic security for all and allows for philanthropy.
This isn’t about punishing the rich; it is about ensuring economic prosperity for future generations and Econ 101 in terms of fiscal policy. As for U.S. policy, we must not allow a further dismantling of the estate tax and should seek to make it truly more fair for all (taking into consideration the economy, debt, and other taxes).
Monetary and Fiscal Policy: Crash Course Government and Politics #48. Congress enacts a fiscal policy (what gets taxed and spent). The FED enacts the monetary policy (interest rates and such). Together they affect the money supply and work toward ensuring the short and long term health of the economy.
TIP: See a similar argument for flat tax vs. a progressive tax.
FACT: Today, 99.8 percent of estates owe no estate tax at all, according to the Joint Committee on Taxation. Only the estates of the wealthiest 0.2 percent of Americans — roughly 2 out of every 1,000 people who die — owe any estate tax. This is because of the tax’s high exemption amount, which has jumped from $650,000 per person in 2001 to $5.45 million per person in 2016. Only 2 out of ever 1,000 estates will ever owe the tax on dollars over the exemption amount. SEE: Ten Facts You Should Know About the Federal Estate Tax.
The laws of accumulation will be left free; the laws of distribution free. Individualism will continue, but the millionaire will be but a trustee for the poor; entrusted for a season with a great part of the increased wealth of the community, but administering it for the community far better than it could or would have done for itself.
Of such as these, the public verdict will then be: “The man who dies thus rich dies disgraced.”
[Self-directed Philanthropy], in my opinion, is the true Gospel concerning Wealth, obedience to which is destined some day to solve the problem of the Rich and the Poor, and to bring ‘ Peace on earth, among men Good-Will.”
– From an essay by Andrew Carnegie on individualism and the need for a progressive estate tax.
Whenever a tax is imposed, each taxpayer becomes responsible for the redemption of a small part of the debt which the government has contracted by its issues of money, whether coins, certificates, notes, drafts on the treasury, or by whatever name this money is called. He has to acquire his portion of the debt from some holder of a coin or certificate or other form of government money, and present it to the Treasury in liquidation of his legal debt. He has to redeem or cancel that portion of the debt…The redemption of government debt by taxation is the basic law of coinage and of any issue of government ‘money’ in whatever form.— Alfred Mitchell-Innes, The Credit Theory of Money, The Banking Law Journal