Freeman

IT JUST AIN'T SO

The Death Tax Is Fair?

Repealing the Estate Tax Would Benefit Everyone

OCTOBER 01, 2000 by RANDALL G. HOLCOMBE

Filed Under : Taxation

When George McGovern was running for president in 1972, he gave a talk to a group of auto workers in which he advocated increasing the estate tax, and his audience reacted by booing his position. McGovern was baffled by the audience reaction, and after his talk, commented to his own advisers, “It’s not like they are going to inherit anything.” What McGovern found out was that even people of modest means still perceive the unfairness of the estate tax. Once you have earned something, it should be yours, and it is unfair for the government to confiscate it when you die. A more subtle lesson is that when people evaluate political proposals, they don’t always just ask, “what’s in it for me?” Sometimes they prefer policies that seem fair, even if those policies do not benefit them directly.

Paul Krugman raised these same issues in an essay titled “Death and Taxes,” New York Times, June 14. He analyzes the House of Representatives vote to repeal the inheritance tax by considering who gains and who loses, and concludes that the vote was a simple matter of special-interest legislation favoring a small minority of rich people at the expense of everybody else. If people knew the truth, he asserts, the legislation would face a much rougher ride. But Krugman’s argument is suspect on two grounds. First is his analysis of the facts about the inheritance tax. Second, and probably more significant, is his implication that people support legislation only when it benefits them.

Effects of the Inheritance Tax

Krugman correctly notes that a large share of total private wealth in the United States is held by a small percentage of the population. If people knew how skewed the distribution of wealth really is, Krugman asserts, support for the repeal of the estate tax would plummet. The current estate tax hits only about 2 percent of all estates, so Krugman says it is levied almost entirely on the very rich. The raw numbers do not tell the entire story. One reason the tax is levied on so few estates is that there are ways, both legal and illegal, to avoid it. The 2 percent number is artificially lower than it otherwise would be because the estate tax causes people to minimize their taxable estates. Many more people are directly affected by the tax.

Another problem with repealing the estate tax, Krugman says, is the revenue loss to the Treasury. However, reputable academic studies calculate that the estate tax may actually be a net drain on the Treasury, because people engage in activities to avoid the tax when they are alive, and this legal tax avoidance (such as setting up foundations into which one can transfer assets) lowers federal income tax revenues by more than the estate tax collects. On net, the estate tax raises very little revenue for the Treasury, and may raise no net revenue when all its effects are considered. It is a tax that provides little benefit to anybody, but costs a few people a significant amount—and not just money. Krugman notes that cases where the estate tax forces heirs to sell the family farm or liquidate the family business to pay the tax are rare, but then again, so are cancer deaths from secondhand smoke, and the federal government works hard to prevent those rare tragedies.

Krugman likes the estate tax because it helps level the playing field, but it does so in the worst possible way. It hurts those at the upper end of the wealth distribution, but provides no significant benefit to those at the lower end. It follows the easy route in leveling the playing field because it is always easier to hurt the rich than it is to help the poor.

Despite the basic statistics Krugman presents, a broader analysis of the proposed repeal shows that it is a very desirable move. It helps some, hurts nobody, and it would enhance the efficiency of the economy. If people really understand the issues, and if they consider only their own narrow self-interest, repeal of the tax should be widely supported. The only people who could reasonably mount an opposition to the tax are people who do not really understand the policy’s effects, or those who are so envious of rich people that they are willing to hurt everyone a little in order to hurt America’s wealthiest citizens a lot.

Fairness

I believe that Krugman has painted an overly simplistic picture of the facts, but for sake of argument let’s say that Krugman is right: repealing the estate tax would benefit a small fraction of the population, and the wealthiest fraction at that. Analyzing the estate tax the way Krugman does implies that people favor public-policy changes only when those changes bring them direct tangible benefits. Do people really decide whether they favor a specific piece of legislation based simply on whether it provides direct benefits to them?

Americans in general, whether they are auto workers or Silicon Valley entrepreneurs, believe that when people earn their income honestly, that income becomes their property. It does not belong to other people, or to the general public, or to the government. The money people pay in taxes is their money, and if they get a tax cut, it is not a benefit to them, as Krugman suggests; it is just less of a cost. Letting people keep more of the money they earn is a good thing. Of course most tax cuts go to the people with the highest income and the most wealth, because those are the people who pay most of the taxes.

Krugman is right that in most cases paying the estate tax does not cause heirs to have to sell the family farm or business, but so what? Is it any less unfair that the people who invested in stocks and bonds, financing the growth of the American economy, rather than buying boats, expensive cars, and lavish vacations, must turn over so much of their estate to the government when they die? Those people already paid income taxes on the money when they originally earned it, and it shouldn’t be taxed again when the people who paid taxes on it the first time die. The family farm or small business cases simply help illustrate the point.

I have argued that once the facts are understood, repealing the estate tax will be seen to benefit everyone, not just the rich. But even if Krugman is right and the benefit will only go to a small fraction of America’s richest citizens, the tax is still unfair. People sense that unfairness, and that is the real reason there is not more opposition to its repeal. Opposition is weak not because people hope to benefit directly from the tax, but because people believe that once wealth is fairly earned, it is the property of the owner, and they oppose government confiscation.

—Randall G. Holcombe
DeVoe Moore Professor of Economics
Florida State University

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