Rethinking Estate Taxes

6/11/20

The confluence of the Covid-19 pandemic, the Black Lives Matter movement, and the killing of George Floyd and its aftermath of demonstrations seems to be generating a growing chorus of calls for expanded federal spending, but we seem to be lacking the willingness to pay for it. Given the structural problems we’re facing in our society, we need to figure out a way to untie this Gordian knot.

Unfortunately, the “no new taxes” mantra is a powerful impediment. I believe, however, that if people understood how taxes are generated, they’d be more open to tapping into sources that have thus far been overlooked.

The accompanying chart reflects the composition of federal tax collections. It’s worth noting that half of the payroll taxes are directly paid by wage earners, with the other half paid by employers. Some studies have concluded, however, that wage earners actually bear a greater portion of that payroll tax burden, because employers are seen as shifting a portion of their burden by paying lower wages than they otherwise would pay in the absence of payroll taxes. Bottom line, working Americans bear something on the order of two-thirds of the tax receipts collected, or more.

The segment that I want to turn attention to is the “Other” category, which is largely derived from profits on assets held by the Federal Reserve System, with about a fifth of this category coming from estate taxes. Put another way, estate taxes contribute less than 1 percent to total federal tax revenues.

Let’s understand that those who have accumulated wealth currently have the two carveouts to transfer their wealth tax free: distributions of $15,000 per individual per year, for as many people as they care to arrange, and a separate allowance for a lifetime gift of $11.58 million per person or $23.16 million per couple.

I think most American’s would judge the current allowances to be too high. To be fair, congress seems to have come to the same conclusion — sort of. Starting in 2025, the lifetime excemption will be reduced to $5 million per person or $10 million per couple. Even this reduced level is an overly generous allowance.

What’s the magic number? In my judgment, the $15,000 per year per person exemption by itself is sufficiently generous — perhaps overly so. Someone who receives that allocation, say, for 10 years, earning an investment return of just 5 percent would end up with assets worth $200,000 by the end of the 10 years. People are free to give whatever they want; but should our tax system serve to bestow a life of privilege on those who were lucky enough to be born into wealth? I think not. For recipients, gift proceeds should be taxable, like any other income that they receive. The sense that children of the wealthy are entitled to literally any inheritance on a tax-free basis needs reconsideration.

It’s true that such gifts would have already been taxed– or should have been — so I admit that I’m arguing in favor of double taxation, but overriding considerations are at work. America aspires to be a land of opportunity. The game is rigged, however, when some start out with a substantial leg up, financially. Some level of inequality is unavoidable, but it doesn’t have to be as extreme as it currently is. Eliminating estate tax exceptions will help level that playing field while at the same time providing greater flexibility to address the spending priorities that people are now demanding. Congress has been talking about closing tax loopholes … forever. That effort can begin here.

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Kawaller holds a Ph.D. in economics from Purdue University and has held adjunct professorships at Columbia University and Polytechnic University.

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Ira Kawaller

Kawaller holds a Ph.D. in economics from Purdue University and has held adjunct professorships at Columbia University and Polytechnic University.