Forget the Estate Tax: America Needs An Inheritance Tax
The Republicans have convinced me about one tax issue: It is time to end the estate tax - or the “death tax” in their lexicon.
But that’s where our views diverge. They would end the estate tax and replace it with nothing (other than a huge hole in the federal budget). With inherited wealth serving as a significant source of inequality in America, which is real and growing problem, I propose that we replace the estate tax with an inheritance tax, in which individuals receiving an inheritance would pay tax - like an individual pays tax on other forms of labor or capital income.
While there are a myriad of options about the precise structure of an inheritance tax, Lily Batchelder of NYU has studied the issue and proposed that heirs receiving lifetime inheritances greater than $2.3 million pay a 15 percentage point surtax on the excess. She also proposes to replace stepped-up basis with carryover basis for bequests. Under her proposal, as under the current estate tax, the number of people affected would be tiny - roughly 0.2 percent of heirs each year.
The benefits of an inheritance tax, like the one proposed by Batchelder, would be to enhance unambiguously equity and efficiency, while making the tax system simpler.
Under an estate tax system, the size of your tax bill does not vary whether you distribute your estate to one or one hundred people - or whether you distribute the money to Bill Gates or the security guard at the property gates. With an inheritance tax, who you disperse your estate to matters: it distinguishes between (a) heirs who receive large and small gifts, and (b) heirs who are wealthy and those who are not. As a result, it would make the tax system more progressive.
Further, the proposal to replace stepped-up basis with carryover basis ends a distortion in the current estate tax system: Donors near death have an incentive to hold on to appreciated assets solely for tax reasons. The use of carryover basis within a wealth transfer system will thus enhance efficiency by removing an unnecessary distortion in the tax system.
Finally, an inheritance tax will make the tax system simpler. The current estate tax is a boon to tax lawyers and accountants. With an inheritance tax, tax planning costs will be reduced. In addition, experience from other countries shows that an inheritance tax works in practice.
A progressive tax system should be attuned to ability to pay and unearned advantage. Replacing the estate tax with an inheritance does just that.