Inheritances Should be Taxed the Same as Income

By Maya MacGuineas
Director, Fiscal Policy Program, New America Foundation

The Chicago Tribune
September 14, 2000

Should death be taxed? Congressional supporters claim that this is the issue that was at the core of the failed legislation to repeal estate and gift taxes. Certainly this type of an exit tax would seem not only morbid but unfair. But estate and gift taxes are hardly a tax on death; most people who die don't pay them, and some people who are living do. Clever marketing, starting with the label "death tax," would have you believe otherwise and has successfully diverted attention from the real question: Should unearned income be taxed?

The Republican-sponsored bill to repeal estate and gift taxes is a boon for the heirs of wealthy benefactors who are already exempt from paying taxes on what they inherit. Under current law an estate can transfer up to $675,000, untaxed, with unlimited exemptions for charitable giving and gifts to spouses. Additionally, individuals can give tax-free gifts of up to $10,000 a year to as many people as they like. Beyond exemptions, estates and gifts taxes are levied on the donor at rates ranging from 37 to 55 percent. Due to the large exemptions, most estates aren't touched, and fewer than 2 percent pay any tax. As a result, their lucky beneficiaries can receive hundreds of thousand of dollars in tax-free income, and with a bit of estate planning, they can receive much more.

Critics of the estate tax decry it as the unfair double taxation of income--a red herring if ever there were one. First, the estate tax catches a substantial amount of income that has never been taxed before. Capital gains income that is passed on at the time of death is exempt from taxation due to the "step-up-basis" at death. This oddity of the tax code allows unrecognized capital gains to go untaxed forever. While estate tax repeal legislation would eliminate this exemption for extremely large gains, most of the exemption would remain in place. Second, the argument of double taxation is meaningless in a system where many workers' earnings are already taxed multiple times through the income and payroll taxes when earned and then by sales taxes when consumed. Double and even triple taxation are a reality of the tax code, which, unless greatly simplified to, say, a single consumption tax, are here to stay.

Meanwhile, complicated and arguably arbitrary estate and gift taxes do indeed need to be reformed. But the objective should not merely be to reduce taxes for millionaires and billionaires. Under current estate and gift taxes and proposed reforms alike, recipients can receive a $10,000 gift, a $675,000 bequest or even $1 million from an estate and are not taxed on a single dollar of that income. This fundamental exemption of unearned income represents one of the greater inequities in the tax code.

A far better approach would be to ensure that people are more fairly taxed on all the income they receive. This could be achieved simply by scrapping estate and gift taxes entirely while replacing them with the existing income tax.

Sure, some will argue the recipient's parent, or great-uncle, or whoever originally earned the income already paid income taxes. But at the time of its transfer it is transformed into income for someone new and should be taxed as such. Why should one person owe a payroll tax on the first dollar they earn while another pays no taxes on the first million they don't? If beneficiaries were taxed on the transfer of wealth, when they received $10,000 from a relative, it would be included in and taxed with the rest of their income. The same would be true for someone who inherited $10 million or $10 billion.

The revenue gains from taxing inheritances would be significant since most gift and estate income that currently goes untaxed would be included in the income tax. This widening of the tax base would in turn allow marginal tax rates to be decreased. Not only would the change make taxing estate income simpler and fairer, it would provide the means for an across-the-board tax reduction for all Americans, not just the richest few.

Favoring unearned income over that which is earned should not be the policy in a country where the ethic is that an individual should work hard, be rewarded accordingly and enjoy the fruits of their labor. And while that goes for their heirs as well, the emphasis should be on working hard and being rewarded accordingly, not merely enjoy the fruits of their benefactors' labor.

While death should not be taxed, income should.

Copyright: 2000 The Chicago Tribune

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