Thursday, October 11, 2007

Death and taxes - A British Perspective

Category: Estate and Inheritance Tax

As the Estate Tax Debate is likely to heat up as we head into the 2008 election season, I found the below articleNew Statesman - Death and Taxes from British political philosopher Martin O’Neill debating Great Britain's Inheritance Tax (which is structured similarly to our federal estate tax) excellent reading and very enlightening.

The Article begins "In a letter to his friend Jean-Baptiste Leroy in 1789, Benjamin Franklin famously opined that “in the world nothing can be said to be certain except death and taxes.” Franklin was surely right about this, just as his judgment was sound in so many other matters – after all, this was the man who told us that “beer is living proof that God loves us and wants us to be happy”. But it is astonishing how often passions become enflamed, and good sense goes out the window, when we encounter the heady mix of mortality and tax. "

It goes on to highlight some on the mis-perceptions about the British Inheritance Tax that are very similar to the many time unwarranted fears about the US estate tax:

(1) Most People Pay Nothing (or at any rate not very much…)At the current £300,000 threshold, only the richest 6% of estates pay anything. One common form of misjudgement is that many people who will not be affected IHT nevertheless think that they will be. A striking example of this kind of thinking comes from the U.S., where the Estate Tax threshold kicks in only at $2,000,000, or for the top 1% of estates. Nevertheless, Bush’s attempt at repealing the estate tax enjoyed widespread public support among the less well off. Surveys found that 20% of Americans believed that they were in this top 1%, with a further 20% expecting to come into this bracket in the near future!

The emphasized text speaks for itself.

(2) Arguments About ‘Double Taxation’ are Bad Arguments:Perhaps the strangest,
and yet most pervasive, aspect of opposition to IHT is that many people say that
‘double taxation’ is intrinsically unfair. But, if this were true, then it would
be intrinsically unfair to levy any form of tax on the expenditure of post-tax

The reality is that in a tax system that has parallel forms of taxation (federal, state, local), there is double taxation. Federal income tax supports the United States. Sales tax supports New Jersey. Real estate tax supports my local town. The reality is that all these governmental entities need funds to operate. And the estate tax REPLACES the capital gains tax for heirs due to the step up in basis that eliminates tax on appreciation in assets during lifetime (and all Americans benefit from this, not just those in the 1% that pays the estate tax).

(3) If not Inheritance Tax, then what?Inheritance Tax is a tax that falls disproportionately on the old (the typical case is of 60 year-olds inhering from 80 year-olds) and the rich. If we wish to repeal it, or raise IHT thresholds, then, unless we want to reduce government expenditure, the shortfall needs to be raised elsewhere. The chances are that it will be raised to a greater degree from those who are younger and poorer than those affected by IHT. Many of the opponents of IHT would be less sure of their position if questions about IHT were framed in a different way. Instead of “Would you like inheritance tax to be reduced?” the question should be “Would you like to replace inheritance tax with increased income tax or corporation tax?”. Here again, thinking of IHT as part of a tax system, rather than in abstract isolation, helps to make the issues clearer.

This point is my main concern with the charge to repeal the estate tax. Assuming that government expenditures remain exactly the same, if the government takes in less revenue from elimination of the estate tax, where is it going to get the shortfall from? Likely you and me.

(4) Why Free Market Conservatives Should Love Inheritance Tax. Inheritance Tax is often seen as a policy of the Left rather than the Right, and it’s certainly true that there are lots of good egalitarian reasons that support IHT. But this is only half of the picture. Those on the Right, and especially those who believe in the usual justifications for the free-market, should be just as enthusiastic as the staunchest socialist about the preservation of IHT. Here’s why. Let us assume that we believe in the glories of the free market economy. If we give people responsibility, and set them on their own two feet, then they’ll work hard and prosper. A free market in trade and employment gives us, let us suppose, a dynamic, innovative and thriving economy. It does this by incentivizing hard work, and letting economic rewards flow to those with the best ideas and the greatest capacity for hard graft.

But, if this is our vision of society, we surely must admit that the unearned windfall gains of inheritance tax distort this picture. Large inheritances distort the level
playing field which would allow the dynamic and innovative to prosper. If welfare payments cause listlessness and sap dynamism, then we can only assume that large unearned windfalls will do likewise. Indeed, these were precisely the sorts of arguments given by Teddy Roosevelt when he proposed an American federal
estate tax in 1906. As Andrew Carnegie (another proponent of IHT) put it “the
parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and leads him to lead a less useful and less worthy life than he otherwise would.” One need hardly point out that neither Roosevelt nor Carnegie were approaching these issues from the left.

The solution? Inheritance tax can be used to fund education so as to create that level playing field and broad opportunities, or, perhaps, used to fund capital grants to young entrepreneurs. This is exactly the sort of scheme favoured by Bruce Ackerman and Anne Alstott, in their book The Stakeholder Society, where they advocate capital grants to each individual of $80,000 at the start of their working lives, funded by a progressive estate tax. One of the interesting features of this sort of scheme is that it is all about using the state to facilitate individual responsibility and to create opportunities, rather than simply doling out welfare. This is a much purer vision of a free market society than societies that are gummed-up and ossified by inherited advantage.

I took a tax theory class once long ago that echoed how the estate tax supports the capitalist society we are and is not merely a form of socialism. While I don't know if the government taking to give is realistic (I would rather save my own $80,000), the estate tax does support current government expenditures that could not exist without funding.

(5) Why the Left Needs To Be Less Defensive about Inheritance Tax. Just like the Democrats in the US, the Labour Party has tended to be somewhat defensive when reacting to proposals to abolish or reduce IHT. Rather than simply emphasizing that not all that many people pay IHT, Labour should be trying the difficult task of transforming public opinion on the issue. Perhaps the strongest arguments for IHT appeals to ideas of reciprocity and fairness that are very commonly shared.

Teddy Roosevelt took the view that “The man of great wealth owes a peculiar obligation to the State, because he derives special advantages from the mere existence of government.” There would be no good in being wealthy if one could not enjoy stable property rights, the protection of the police, and the peace of a well-defended country, all of which need to be paid for. And individuals do not make their money in a vacuum, but by building on a broad history of innovation and development. This sort of reciprocity argument is also made by Bill Gates, Sr., father of the Bill Gates of Microsoft, in his book Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes. This sort of argument can get broad purchase with those of every political stripe, as is demonstrated by the fact that Roosevelt and Gates are hardly “soak the rich” firebrands or loonie lefties.

This point underscores the basic element of a progressive tax system - those who have more pay more because they have more disposable dollars (dollars not needed for the basics of food and shelter) for the community. Unless we go to a flat tax, a progressive tax system is what we have to work within.


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