A new paper was released this week in the Pepperdine Law Review by Paul Caron (of the excellent TaxProf Blog) and James Repetti called Occupy the Tax Code: Using the Estate Tax to Reduce Inequality. This paper argues that due to the growing wealth inequality in America we can and should use the 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. to redistribute income. They “think that [the federal wealth transfer 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. is reducing inequality] because [it] clearly reduces the amount of wealth transferred by the largest estates to heirs.” They also argue it may not be the case that it reduces savings. However, even ignoring the effects on savings they miss some of the most burdensome costs of the estate tax and overstate the effects the tax may have on inequality.
The biggest costs that they missed are compliance costs. Actually, there is no mention of compliance costs associated with the estate tax at all. As research has shown, the estate tax’s compliance costs associated with the estate planning industry exceeds the revenue of the federal government from the estate tax. All of these resources could be employed elsewhere in the economy. Even worse, this huge compliance cost comes with very little benefit: Only .42 percent of federal revenue in 2012 came from the estate tax. Even more, collecting this revenue may actually be a drain on total revenues, as complete repeal of the estate tax would increase economic growth, thus increasing total revenue through the income tax; a pretty bad deal for the government overall.
As for income inequality, their one piece of evidence that the estate tax does reduce inequality is that in the past decade, the average effective tax rate on gross estates was around 16 percent. This number really doesn’t mean anything besides that those who paid the estate tax on average paid 16 percent of their gross estate to the government. It says nothing about who those people were or how they got their wealth, or whether the money was used to reduce inequality. As we have pointed out previously, studies found that only 2 percent of income inequality was explained though inherited wealth while 27 percent of all wealthy households accumulated wealth through inheritance. In other words, of the small number of people affected by the estate tax, only a fraction of them have inherited their wealth. Rather than reducing inequality, more likely you are just taxing those who have earned their money in the current generation or even small businesses and farms with illiquid assets. The former Chairman of the Council of Economic Advisors under Clinton and Nobel laureate, Joseph Stiglitz argued that the estate tax could actually increase inequality. So it is not entirely clear that the estate tax has any effect on inequality.
Taxes should aim to be simple and neutral. The estate tax is neither; it creates a large loss to society through compliance costs and is far from efficient, distorting behavior and creating an entire industry around it. Looking at the economic costs of the estate tax goes far beyond just looking at its effects on savings and how much tax revenues it collects. The costs are a lot worse than those pointed out in this paper and the benefits are not so clear.
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