The Case for Abolishing Death Taxes

Policy Backgrounders | Taxes

No. 142
Friday, June 27, 1997
by Bruce R. Bartlett

The Effect of the Tax on Capital

Figure III - Source of Wealth for Wealthiest 5 Percent of Americans

"The marginal tax rate on pension assets has risen to more than 85 percent - and con be as high as 99.73 percent in some states."

With intergenerational transfers accounting for as much as 80 percent of the nation's capital stock, according to a study by Laurence Kotlikoff and Lawrence Summers, this means that the estate tax is a direct tax on capital.16 Since the capital stock is the nation's wealth, it is reasonable to say that the nation's capital stock is automatically reduced by at least the amount of the tax. The effect on capital stock is even larger if it reduces the savings rate as well.17

Of course, anything that reduces capital formation in the economy ultimately makes everyone poorer. That is why economists historically have warned against estate taxes.

Adam Smith: "All taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labor."18

David Ricardo: "It should be the policy of governments...never to lay such taxes as will inevitably fall on capital; since by so doing, they impair the funds for the maintenance of labor, and thereby diminish the future production of the country."19

C.F. Bastable: "Succession duties first of all possess the grave economic fault of tending to fall on capital or accumulated wealth rather than on income; they therefore may retard progress."20

By contrast, those wishing to destroy the capitalist system have always been enthusiastic supporters of heavy estate taxes. It is worth remembering that the third plank of The Communist Manifesto says that the right of inheritance should be abolished.21 Even today, there are those who believe it is immoral to allow people to inherit anything.22

Ironically, the negative impact of the estate tax on saving and capital formation negates much of the redistributive effect of the tax. According to an article by Joseph Stiglitz, former chairman of the Council of Economic Advisers under President Clinton, to the extent that the estate tax lowers the capital stock it raises the return to the remaining capital. Since the rich already own most of the existing capital, the effect of the estate tax is to actually make them richer.23

Indeed, existing high estate tax rates appear to do virtually nothing to equalize the distribution of wealth.24 Recent studies, in fact, have argued that wealth has never been more unequal than it is today.25 One reason why estate taxes have less impact on wealth distribution than people imagine is that inheritances constitute less of the wealthy's assets than is usually thought. As Figure III shows, for those in the top 5 percent of the wealth distribution, inheritances make up only 7.5 percent of their wealth. Indeed, even among the super-rich, inheritance counts for less than commonly believed. According to one study, of the 265 separate fortunes represented by the Forbes 400, 157 or 59 percent were new wealth. Only 108 or 41 percent were inherited.26 Another study concluded that 75 percent to 85 percent of the rich throughout American history were self-made.27

"The impact of the estate tax on the distribution of wealth is limited because inheritances constitute little of most wealthy people's assets."Finally, the estate tax imposes large dead weight costs on the economy. First is the cost of employing large numbers of Internal Revenue Service agents to collect estate and gift taxes. Second is the cost of employing legions of tax lawyers to avoid the tax. Aaron and Munnell report that some 16,000 members of the American Bar Association cite trust, probate and estate law as their primary area of concentration. They conclude that compliance costs alone may eat up a sizable fraction of all estate tax revenues.28 On the other hand, one commentator has suggested that the government may get more revenue from taxing the incomes of estate tax planners than from the estate tax itself!29

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