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India! I dare you to be rich

The case against inheritance tax

In DOF I've argued vigorously against James Meade's (a Nobel prize winner in economics) arguments for an inheritance tax. John Rawls took on Meade's arguments to propose a dramatically enhanced welfare state with strong redistribution.

An article in The New York Times today by Russell Roberts (who is a research fellow at Stanford University’s Hoover Institution and professor of economics at George Mason University) and co-author of Cafe Hayek prompted me to make a comment on the Cafe Hayek blog. 

I encourage you to read Russell's argument but note two other key arguments that I've made in DOF. Let me reproduce the entire section:

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Meade advocated a highly aggressive tax on inheritance. We could, in consequence, acquire wealth for ourselves but not be permitted to pass it on. That is simply unacceptable. We live through our children, and while we may not work only for their sake, we have in mind the continuity of our life that our children represent. Our children are us. Rawls wanted the ‘wide dispersal of property’ as part of property-owning democracy. This, he believed, ‘is a necessary condition … if the fair value of the equal liberties is to be maintained.’[1] But that’s not true! Indeed, were such forced dispersal of property to occur, there would be no liberties left because such dispersal is unnatural and coercive. He also wrote, confoundingly, that ‘One naturally imagines that the greater wealth of those better off is to be scaled down until eventually everyone has nearly the same income. But this is a misconception, although it might hold in special circumstances’[2]. This view significantly contradicts his more fundamental statement that ‘[a]ll social values – liberty and opportunity, income and wealth, and the social basis of self-respect – are to be distributed equally’ [emphasis mine].
 
To thus say that Rawls’s work is replete with confusion would be an understatement, with the implications of his second principle destroying his first principle. And basic puzzles remain. Why would anyone labour their whole life if they were unable to pass on the fruits of this labour to their children? Transfers of assets from one generation to another should be treated seamlessly, ruling out all inheritance taxes (this is also fundamentally a problem on the ground that those families that tend to die at an average age of 50 would be taxed far more heavily than those that die at age 90).
 
As I noted in my comment at Cafe Hayek, This way families that have differential genes for longevity will be taxed differently. Greater nonsense (in terms of a redistributive theory) cannot be thought of.
 

[1] Rawls, John, A Theory of Justice (1971), Cambridge, Massachusetts: Belknap Press of Harvard University Press, 1999, p. 245.

 

[2] Rawls, John, A Theory of Justice (1971), Cambridge, Massachusetts: Belknap Press of Harvard University Press, 1999, p.252.
 
ADDENDUM 2 April 2011
Another thing occurred to me today in favour of free intergenerational transfer – that it is Pareto optimal. This is clearly an exchange where one party (the inheritor) is made better off without harming anyone (the inheritee, or bequestor, who is dead and can't be harmed). A Pareto improvement should not be touched by the state at any cost.
 
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Sanjeev Sabhlok

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23 thoughts on “The case against inheritance tax
  1. Surya

    Sanjeev,
    I find inheritance tax morally reprehensible too. But I am not so sure on logical grounds.
    If we accept that income should be taxed, then doesn't it follow that inheritance is also an income? And is double taxation a proper argument here? My company pays me out of it's earnings which have already been taxed. And I have to pay tax again too. This can also be called double taxation. The inheritor is also a unique person and during inheritance he has gained an income. Shouldn't this be considered a part of his income and  tax levied on that? I am not sure how it is done actually. If after inheritance tax, the remaining amount is still considered for income tax, then it is wrong. Otherwise I don't find it logically wrong.
    This is an issue I have been unable to come to a clear conclusion about. Please clarify if you find my argument wrong.
    Regards,
    Surya

     
  2. Surya

    Sanjeev,
    I find inheritance tax morally reprehensible too. But I am not so sure on logical grounds.
    If we accept that income should be taxed, then doesn't it follow that inheritance is also an income? And is double taxation a proper argument here? My company pays me out of it's earnings which have already been taxed. And I have to pay tax again too. This can also be called double taxation. The inheritor is also a unique person and during inheritance he has gained an income. Shouldn't this be considered a part of his income and  tax levied on that? I am not sure how it is done actually. If after inheritance tax, the remaining amount is still considered for income tax, then it is wrong. Otherwise I don't find it logically wrong.
    This is an issue I have been unable to come to a clear conclusion about. Please clarify if you find my argument wrong.
    Regards,
    Surya

     
  3. Surya

    Sanjeev,
    But having said why I find inheritance tax logically a part of income tax, I should mention that inheritance in itself is a very desirable thing. Of course we have the laissez faire point of view, where I can ask others what is their business when I want to give my hard earned wealth to any one I please. As you said, leaving wealth behind for one's children is a great incentive in itself. If we take that away we would be seriously impairing wealth creation. But there is another important argument too. Inheritance helps in capital accumulation. Now the left liberals usually see life as a race. So they ask why should a rich kid be given a head-start. But life is not a race. We are all not battling each other. A person becomes rich only because the consumers have placed trust in him. And he is best suited to make decisions on the wealth thus acquired. If we should stop inheritance completely and require everyone to start from scratch everytime, the society would be much poorer, because the government after confiscating the wealth would re-distribute it according to it's political preferences. This would re-distribute capital to people who cannot make proper use of it and wealth creation is impaired. Now people might ask what if government re-distributes the wealth to deserving, hard-working people? But the question is who makes this decision? We don't have gods living amidst us who can know everything about everyone. The closest we have is a free market. So let the market decide. If the inheritor is not worth his inheritance he will lose the wealth and it will move to more efficient hands. 
    I had to make this comment because most people argue for inheritance tax because they want to dis-incentivize inheritance. That would be harmful to everyone. I think inheritance should be considered a part of the inheritor's income. And income tax should be applied on it depending on the rates for that bracket. But again since inheritance is a one-time transfer and would be much higher than the usual income, applying the same rate would end up confiscating a lot of wealth from the inheritor's hands which is undesirable. That's why we might need this to be considered separately and a lesser tax levied on that.

     
  4. Surya

    Sanjeev,
    But having said why I find inheritance tax logically a part of income tax, I should mention that inheritance in itself is a very desirable thing. Of course we have the laissez faire point of view, where I can ask others what is their business when I want to give my hard earned wealth to any one I please. As you said, leaving wealth behind for one's children is a great incentive in itself. If we take that away we would be seriously impairing wealth creation. But there is another important argument too. Inheritance helps in capital accumulation. Now the left liberals usually see life as a race. So they ask why should a rich kid be given a head-start. But life is not a race. We are all not battling each other. A person becomes rich only because the consumers have placed trust in him. And he is best suited to make decisions on the wealth thus acquired. If we should stop inheritance completely and require everyone to start from scratch everytime, the society would be much poorer, because the government after confiscating the wealth would re-distribute it according to it's political preferences. This would re-distribute capital to people who cannot make proper use of it and wealth creation is impaired. Now people might ask what if government re-distributes the wealth to deserving, hard-working people? But the question is who makes this decision? We don't have gods living amidst us who can know everything about everyone. The closest we have is a free market. So let the market decide. If the inheritor is not worth his inheritance he will lose the wealth and it will move to more efficient hands. 
    I had to make this comment because most people argue for inheritance tax because they want to dis-incentivize inheritance. That would be harmful to everyone. I think inheritance should be considered a part of the inheritor's income. And income tax should be applied on it depending on the rates for that bracket. But again since inheritance is a one-time transfer and would be much higher than the usual income, applying the same rate would end up confiscating a lot of wealth from the inheritor's hands which is undesirable. That's why we might need this to be considered separately and a lesser tax levied on that.

     
  5. Sanjeev Sabhlok

    Dear Surya

    Let me just respond to one comment that will clarify things. Double taxation on the same income is totally reprehensible. So in the case of dividends on shares, the proper thing is to frank them, so that you only pay an amount OVER AND ABOVE the company tax rate if your marginal tax is higher, or get a refund if your marginal rate is lower. This franking system (followed in many western nations) ensures that debt is taxed equally as equity (which ultimately is someone’s income).

    Indeed, when that is done, corporate tax essentially is dissolved, which is what it should be (as I have shown in my articles on public finance) and citizens then pay – as they should, not artificial entities such as companies.

    Re: inheritance it is flawed to say that the inheritor receives this as income so this should be taxed. That is not income but inheritance – an amount that, say, my parents worked hard to save for me. They paid the tax on that already and therefore their income was FULLY TAXED in their lifetime. It is the residue left upon their death, that is theirs and now (say) mine.

    All my income should be taxed as usual, but this inheritance that was already taxed should never be taxed again. No double taxation on the SAME earning is admissible in the free society.

    Let’s also say that in one family Parent A lives for 100 years. Parent A got his only child at age 50. Then an inheritance tax on A’s inheritance would be payable by A once in 50 years.

    Another Parent B lives for 50 years and has his only child at age 25. Let’s say bote these pattern continues for 200 years.

    Then Family B’s income will be taxed equally as A’s, but inheritance will be taxed 8 times in 200 years while Family A’s inheritance will be taxed 4 times only.

    As a result Family B will end up SIGNIFICANTLY POORER than Family A despite earning (let’s say) the same amount of income.

    I don’t see any logic in using genetic factors to redistribute income.

    Regards
    Sanjeev

     
  6. Sanjeev Sabhlok

    Dear Surya

    Let me just respond to one comment that will clarify things. Double taxation on the same income is totally reprehensible. So in the case of dividends on shares, the proper thing is to frank them, so that you only pay an amount OVER AND ABOVE the company tax rate if your marginal tax is higher, or get a refund if your marginal rate is lower. This franking system (followed in many western nations) ensures that debt is taxed equally as equity (which ultimately is someone’s income).

    Indeed, when that is done, corporate tax essentially is dissolved, which is what it should be (as I have shown in my articles on public finance) and citizens then pay – as they should, not artificial entities such as companies.

    Re: inheritance it is flawed to say that the inheritor receives this as income so this should be taxed. That is not income but inheritance – an amount that, say, my parents worked hard to save for me. They paid the tax on that already and therefore their income was FULLY TAXED in their lifetime. It is the residue left upon their death, that is theirs and now (say) mine.

    All my income should be taxed as usual, but this inheritance that was already taxed should never be taxed again. No double taxation on the SAME earning is admissible in the free society.

    Let’s also say that in one family Parent A lives for 100 years. Parent A got his only child at age 50. Then an inheritance tax on A’s inheritance would be payable by A once in 50 years.

    Another Parent B lives for 50 years and has his only child at age 25. Let’s say bote these pattern continues for 200 years.

    Then Family B’s income will be taxed equally as A’s, but inheritance will be taxed 8 times in 200 years while Family A’s inheritance will be taxed 4 times only.

    As a result Family B will end up SIGNIFICANTLY POORER than Family A despite earning (let’s say) the same amount of income.

    I don’t see any logic in using genetic factors to redistribute income.

    Regards
    Sanjeev

     
  7. Surya

    Sanjeev,
    Thanks for the quick reply. I understand your point. You are stating that inheritance should not be considered an income. And your argument that inheritance tax will be unfair to families that have shorter lifespans also makes a lot of sense. So if we should argue against inheritance tax we should argue on these grounds. And to convince people that inheritance should not be considered income would be tough. That requires a kind of thinking where one learns to accept wealth accumulation as a desirable thing. Most people do not accept that. They are focussed on the fact that the inheritor gets to live a better life just by virtue of his birth. But they don't realise that, if they argue that inheritor has no right to get the wealth, then no one else does either. How is taking the wealth away and giving it to a random person correct?
    I will still have to explore this matter in detail to be fully convinced. But thanks for showing some new lines of thinking. And I didn't know of this concept of Franking. Sounds a logical way of taxation.
    And can you also please share what is your opinion on taxing at consumption point rather than at income point? I have heard some libertarians arguing for this. If you had already discussed it in DOF, please post the relevant section.
    Regards,
    Surya

     
  8. Surya

    Sanjeev,
    Thanks for the quick reply. I understand your point. You are stating that inheritance should not be considered an income. And your argument that inheritance tax will be unfair to families that have shorter lifespans also makes a lot of sense. So if we should argue against inheritance tax we should argue on these grounds. And to convince people that inheritance should not be considered income would be tough. That requires a kind of thinking where one learns to accept wealth accumulation as a desirable thing. Most people do not accept that. They are focussed on the fact that the inheritor gets to live a better life just by virtue of his birth. But they don't realise that, if they argue that inheritor has no right to get the wealth, then no one else does either. How is taking the wealth away and giving it to a random person correct?
    I will still have to explore this matter in detail to be fully convinced. But thanks for showing some new lines of thinking. And I didn't know of this concept of Franking. Sounds a logical way of taxation.
    And can you also please share what is your opinion on taxing at consumption point rather than at income point? I have heard some libertarians arguing for this. If you had already discussed it in DOF, please post the relevant section.
    Regards,
    Surya

     
  9. Sanjeev Sabhlok

    You’ve said it very well, Surya: “if they argue that inheritor has no right to get the wealth, then no one else does either.”

    Re: consumption tax – this is not justified by the foundational social contract. I’ve discussed this in my public finance articles as well as in DOF (pl. search electronically). Theoretically the smoothed lifetime income should be taxed – and possibly wealth (in which case a portion of inheritance will come in – but as wealth tax not inheritance tax). That’s all. The argument is based on the ability to pay (price discrimination), which leads to a slightly progressive tax. Consumption tax is OVER AND ABOVE income tax, and this one is particularly regressive (cf. Engel’s law re: consumption), and nullifies the point of having a systematic income tax. In other words, while consumption tax is easy to capture (the idea of income tax is relatively new, earlier everything was a consumption tax of some sort), it is not theoretically justified.

    Regards
    Sanjeev

     
  10. Sanjeev Sabhlok

    You’ve said it very well, Surya: “if they argue that inheritor has no right to get the wealth, then no one else does either.”

    Re: consumption tax – this is not justified by the foundational social contract. I’ve discussed this in my public finance articles as well as in DOF (pl. search electronically). Theoretically the smoothed lifetime income should be taxed – and possibly wealth (in which case a portion of inheritance will come in – but as wealth tax not inheritance tax). That’s all. The argument is based on the ability to pay (price discrimination), which leads to a slightly progressive tax. Consumption tax is OVER AND ABOVE income tax, and this one is particularly regressive (cf. Engel’s law re: consumption), and nullifies the point of having a systematic income tax. In other words, while consumption tax is easy to capture (the idea of income tax is relatively new, earlier everything was a consumption tax of some sort), it is not theoretically justified.

    Regards
    Sanjeev

     
  11. Sandeep Shelke

    Sanjeev,
    Agreed, inheritance tax shouldn't levied. This another scenario which cought me.
    If the wealth collected by my parents is from corruption and loot. And those charges are proved after their death. Not the wealth is with me and I may have utilized max of it. So whatever charges are applicable against my parents why those not be applied to me? Why not to inherit the responsibility too?
    This is very logical if positive is mine then negative too.
    Jai Bharat!

     
  12. Sandeep Shelke

    Sanjeev,
    Agreed, inheritance tax shouldn't levied. This another scenario which cought me.
    If the wealth collected by my parents is from corruption and loot. And those charges are proved after their death. Not the wealth is with me and I may have utilized max of it. So whatever charges are applicable against my parents why those not be applied to me? Why not to inherit the responsibility too?
    This is very logical if positive is mine then negative too.
    Jai Bharat!

     
  13. Sanjeev Sabhlok

    Dear Sandeep

    There is a law of limitations on criminal matters. By all means confiscate wealth that is knowingly stolen, even by the family. A son, when he is 18, is responsible NOT to use stolen wealth.

    Regards
    Sanjeev

     
  14. Sanjeev Sabhlok

    Dear Sandeep

    There is a law of limitations on criminal matters. By all means confiscate wealth that is knowingly stolen, even by the family. A son, when he is 18, is responsible NOT to use stolen wealth.

    Regards
    Sanjeev

     
  15. James Killian Spratt

    In the US, any inheritance over two million dollars is taxed as income.  I believe the reason for that is to prevent huge family dynasties of "owners," who would then tend to have an overwhelming financial advantage over the average citizen, the theory being that ownership should not be rewarded more than labor, lest it create too wide a class divide (which is already happening, mostly because of globalization and the attendant "out-sourcing," which is a disadvantage to the US economy in the short-run, but good for mankind as a whole in the long-run.  The class divide in the US will probably level out over time as the rest of the world gets paid more equably for equal work, and the advantages of out-sourcing diminish.) 
    I think letting inheritors keep the tidy sum, but not the overwhelming advantage, is a pretty fair societal compromise.  (Most people here don't inherit anywhere near two million dollars, so they get to keep all of what their parents worked so hard to accumulate.)

     
  16. James Killian Spratt

    In the US, any inheritance over two million dollars is taxed as income.  I believe the reason for that is to prevent huge family dynasties of "owners," who would then tend to have an overwhelming financial advantage over the average citizen, the theory being that ownership should not be rewarded more than labor, lest it create too wide a class divide (which is already happening, mostly because of globalization and the attendant "out-sourcing," which is a disadvantage to the US economy in the short-run, but good for mankind as a whole in the long-run.  The class divide in the US will probably level out over time as the rest of the world gets paid more equably for equal work, and the advantages of out-sourcing diminish.) 
    I think letting inheritors keep the tidy sum, but not the overwhelming advantage, is a pretty fair societal compromise.  (Most people here don't inherit anywhere near two million dollars, so they get to keep all of what their parents worked so hard to accumulate.)

     
  17. Sanjeev Sabhlok

    Dear James

    Thanks for this info. However, what the US does is not my business. I care for the right thing.

    I reject any concept of “class” (such as “class divide”). Such ideas are socialist and will end up destroying freedom and merit. One can’t be free to earn but then not be free to pass on wealth (which has already been taxed) to one’s children. I’ve also shown why such taxation will fall mostly on families with lower average longevity, and that is simply no basis for taxation.

    A social insurance scheme will take care of adverse situations, and so with the lower limit set at a frugal level, we must never restrict anyone’s maximum wealth – obtained from any source. There is no difference between earned wealth and inheritance: both involve a significant portion of luck. Thus, one’s “earnings” involve a very significant inheritance component (genes, family upbringing, etc.). That’s life. But if a fool inherits wealth, that fool and his money will soon be parted. So be it. Let’s not set arbitrary rules. From where does $2 million come from? Why not $3,251,346? Why should someone with $1,999,999 escape taxes, but not the one with one more dollar of inheritance?

    We should keep all arbitrary rules to the absolute minimum. Already the income tax system is arbitrary. After that has worked its way, let the same rupee or dollar not be taxed twice. Let’s keep things simple and base them on fundamental conceptions of freedom and justice.

    Regards
    Sanjeev

     
  18. Sanjeev Sabhlok

    Dear James

    Thanks for this info. However, what the US does is not my business. I care for the right thing.

    I reject any concept of “class” (such as “class divide”). Such ideas are socialist and will end up destroying freedom and merit. One can’t be free to earn but then not be free to pass on wealth (which has already been taxed) to one’s children. I’ve also shown why such taxation will fall mostly on families with lower average longevity, and that is simply no basis for taxation.

    A social insurance scheme will take care of adverse situations, and so with the lower limit set at a frugal level, we must never restrict anyone’s maximum wealth – obtained from any source. There is no difference between earned wealth and inheritance: both involve a significant portion of luck. Thus, one’s “earnings” involve a very significant inheritance component (genes, family upbringing, etc.). That’s life. But if a fool inherits wealth, that fool and his money will soon be parted. So be it. Let’s not set arbitrary rules. From where does $2 million come from? Why not $3,251,346? Why should someone with $1,999,999 escape taxes, but not the one with one more dollar of inheritance?

    We should keep all arbitrary rules to the absolute minimum. Already the income tax system is arbitrary. After that has worked its way, let the same rupee or dollar not be taxed twice. Let’s keep things simple and base them on fundamental conceptions of freedom and justice.

    Regards
    Sanjeev

     
  19. Sanjeev Sabhlok

    Before I forget, James,

    I have clearly indicated in my two articles on taxation and public finance (on this blog) that some form of wealth tax is necessary in addition to income tax. Therefore while I'm totally against inheritance taxation, the standard rates for wealth tax should apply in this case.

    Regards

    Sanjeev

     
  20. Sanjeev Sabhlok

    Before I forget, James,

    I have clearly indicated in my two articles on taxation and public finance (on this blog) that some form of wealth tax is necessary in addition to income tax. Therefore while I'm totally against inheritance taxation, the standard rates for wealth tax should apply in this case.

    Regards

    Sanjeev

     
  21. James Killian Spratt

    Hi Sanjay,
    I'd hope you'd take the US model as just another to study, if you choose; in no way do I suggest that it's the best, or appropriate for India, although by the theory of "conservation of form,"– i.e., a boat hull made in Mumbai will look very much like a boat hull made in Virginia, because water behaves the same everywhere,– there must be enough similarities to give it a lookover, money and people and their interactions being similar everywhere.
    Two million may reflect some sort of statistical average; I meant to say that the fellow who actually inherits two million is only taxed on the two-millionth dollar, or anything above.  Money standing in bank accounts is not taxed (is it the origin of your objection to inheritance tax, that standing bank accounts are taxed in India?  If so, I can readily see why you would object), although its earned interest income, or stock sales are. The wealthy in the US already pay, pro-rata, more annual income tax than the average person anyway, on the assumption that those who gain the most from society should pay the most back.  It seems we agree on that in principle, don't you think?
    Ha-ha!  Okay, you seem to be a man with a plan, and good luck getting it into place the way you want it.  I can easily see that this will be a real job of work.
    Best regards,
    James

     
  22. James Killian Spratt

    Hi Sanjay,
    I'd hope you'd take the US model as just another to study, if you choose; in no way do I suggest that it's the best, or appropriate for India, although by the theory of "conservation of form,"– i.e., a boat hull made in Mumbai will look very much like a boat hull made in Virginia, because water behaves the same everywhere,– there must be enough similarities to give it a lookover, money and people and their interactions being similar everywhere.
    Two million may reflect some sort of statistical average; I meant to say that the fellow who actually inherits two million is only taxed on the two-millionth dollar, or anything above.  Money standing in bank accounts is not taxed (is it the origin of your objection to inheritance tax, that standing bank accounts are taxed in India?  If so, I can readily see why you would object), although its earned interest income, or stock sales are. The wealthy in the US already pay, pro-rata, more annual income tax than the average person anyway, on the assumption that those who gain the most from society should pay the most back.  It seems we agree on that in principle, don't you think?
    Ha-ha!  Okay, you seem to be a man with a plan, and good luck getting it into place the way you want it.  I can easily see that this will be a real job of work.
    Best regards,
    James

     

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