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The Estate Tax is Double Taxation

3 min readBy: Kyle Pomerleau

This week, Professor Lily Batchelder of New York University published a paper titled “The Silver Spoon TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ,” which argues that the United States should strengthen its wealth transfer taxes, such as the federal estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. . She argues that wealth transfer taxes are relatively efficient and that the next president should increase the estate tax rate, broaden the estate tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , and eliminate stepped-up basis at death.

In making her case for expanded wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. es, Batchelder also argues against some common concerns about wealth taxes. One concern she addresses is the argument that the estate tax is a form of double-taxation:

“Some argue that any income or payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. previously paid by a wealthy individual on gifts and bequests they make should count as tax paid by the heir. But they are two separate people. When a wealthy individual pays his assistant’s wages out of after-tax funds, we don’t think the assistant has thereby paid tax on their own wages. In short, today the income and payroll taxes effectively tax unearned income in the form of inheritances at a zero rate.”

This is a weak argument. Simply because two people are involved in a transaction should not make their exchange of money a taxable event. Batchelder ignores an important distinction that the tax code makes between two types of transactions in the economy: an exchange of money for a final good or service that generates additional income, and a transfer of money between two people that does not.

Generally, the income tax attempts to tax the creation of new income once, as it happens. Take the example of a business that produces a good and sells it to a customer, who buys that good with after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize their earnings. . The business then pays tax on the income generated from that sale. We do not consider the taxation of that business income to be a double-tax of the customer’s income simply because the customer paid tax when they earned it. Rather, this transaction is due to the generation of new income attributable to the business, from a new good or service. This new income should be taxed.

However, a transaction that is the result of a new good or service is distinct from transactions in which no good or service is produced. Money changes hands in the economy all the time without the creation of a new good or service. Alimony is a good example of this. Under current law, the receipt of an alimony payment is considered taxable. However, alimony does not result in new income, because it is simply the transfer of money from one person to another. So to prevent double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. , the payer of alimony is able to deduct it from their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . Transfers like these are generally exempt from additional taxation, in order not to tax the same income twice. The tax code makes a similar adjustment – allowing deduction for payment, but taxing receipt of income – for several other transfers between parties: business interest expenses, payroll expenses, costs of goods sold, and home mortgage interest, to name a few.

Batchelder’s example of the wealthy individual who pays an assistant in after-tax income is a transaction that results in new income. To make her example comparable to a wealth transfer, it would be more appropriate to compare it to the payment of alimony, which is taxed on receipt, but is paid in pre-tax income. With this more accurate comparison, one can see why a wealth transfer tax is clearly double taxation.

Wealth transfer taxes are progressive and some of the proposals that Batchelder argues for, such as eliminating the step-up in basisThe step-up in basis provision adjusts the value, or “cost basis,” of an inherited asset (stocks, bonds, real estate, etc.) when it is passed on, after death. This often reduces the capital gains tax owed by the recipient. The cost basis receives a “step-up” to its fair market value, or the price at which the good would be sold or purchased in a fair market. This eliminates the capital gain that occurred between the original purchase of the asset and the heir’s acquisition, reducing the heir’s tax liability. , are worth considering. However, her paper does not sufficiently rebut the argument that they are a form of double taxation. If the goal is to raise more revenue from high-income taxpayers, there are much more efficient ways to do so. In fact, a 2% increase in the top marginal ordinary income tax rate could completely replace estate tax revenue while reducing the overall tax compliance burden. I still think there are many good reasons to remain skeptical of wealth transfer taxes such as estate taxes.