ONE of the most hated tax is the “inheritance tax” which hardly anyone pays in many countries. An inheritance tax, sometimes referred to as an estate tax, may apply to that accumulated amount so that the government can still get a piece of the action even after the family has held a wonderful service for the one who passed away.
Until recently, this paradox appeared to make raising more money from inheritance tax a no-go region. Yet some are now talking about it as a way to deal with growing inequalities and redistribution between generations while helping raise revenue for the government.
It is fairly right to say that baby boomers have exceptionally stashed wealth tied up in their properties. Still their children and grandchildren are paying sky-high rents from squeezed incomes, and struggle to raise a deposit for a flat. Families also face rising social care cost that could wipe out an inheritance if a parent or grandparent cannot look after themselves.
So, there is a need to seek extra revenue in the coming years with the aim to help the younger generation who have been nailed over in the jobs market as well as the housing market besides helping with their education. Also, there is a need to provide the healthcare and social care for those people falling into the aging group. Hence, it appears that promoting the role wealth taxes and inheritance tax has emerged as a part of that mix.
Proponents and risk to the inheritance tax
The inheritance tax is expected to reduce the levels of income inequality. The haves are getting more than the have nots at the moment. And so, this tax will help to equalise the playing field. The money collected could be used to fund for security, infrastructure, social programmes and other needs that benefit everyone.
Besides, it is envisaged that such tax will increase charitable donations. Driven by the inheritance tax, many in the wealthy class could start donating funds to charitable as a way to reduce their overall net worth. This will help reduce their tax liabilities after death.
In summary, the proponents for inheritance taxes is that they promote fairness and equality. Heirs have rarely done anything to deserve the money that comes their way. Letting huge fortunes pass across generations was “of great and genuine detriment to the community at large”, would doubtless be shocked at the situation today. It opens up options for raising more money and it helps with the perception because at the moment inheritance tax is seen as a tax on giving.
However, the risk with such taxes is that it can potentially reduce wealth accumulation, induces tax avoidance, or both. The inheritance tax faces deep-rooted hostility. People in general from across the scale dislike this levy mainly because it will be imposed at a time of grief on the money on which the deceased had already paid tax.
At the same time, it seems like the inheritance tax will be paid by the middle classes while the rich will more likely avoid it by giving the assets away and pay advisers to find other ways and means round it including investing in businesses that all of which are exempt.
Furthermore, inheritances are deeply personal and the biggest single gift that many give to causes they believe in and loved ones they may have cherished. Many (living) people would feel wronged if they could not provide for their children. If anything, as the expression of their last wishes, bequests carry more weight than their passing fancies do.
Besides, the revenue collected from inheritance tax could be low with respect to the overall revenues collected for the year. The costs of bringing in this cash is also the highest per capita when compared to any other tax revenues. This is because the government incurs large levels of expense in the valuation and collection of the revenues it deems is owed.
It reduces available capital. Even if a business is able to survive the inheritance tax, the amount that is owed will severely limit the amount of liquid cash the heirs will have available. This could force a potential bankruptcy or drive the company out of business over time because of the tax liabilities. In some cases, it could even be said that some of the income being taxed has already been taxed through other methods, creating a situation that is only beneficial to the government.
It can force families to sell their businesses. This tax could potentially see businesses winding up by selling their assets simply because the government requires this tax to be paid. That forces an uncomfortable question: would the tax revenues generated by the business if it were allowed to survive be greater in the long term than the short term gains from the inheritance tax?
In short, there have long been concerns that inheritance tax might discourage entrepreneurship because successful entrepreneurs would be especially likely to accumulate enough wealth to be subject to the tax. The tax might discourage entrepreneurial individuals from starting a business in the first place or from taking risks. Even if the entrepreneur retains the business, the estate might need to sell it to raise cash to pay the tax. Entrepreneurs might accumulate additional assets, such as life insurance, so that the estate can meet tax obligations, but those assets are diverted from business investments.
This tax could affect entrepreneurship decisions in many ways. They could affect the decision to start a business or terminate it, or they could alter decisions within the business, in turn affecting investment, employment, and the rate of growth. These taxes might affect the decisions of investors (thereby affecting the availability of capital) in a new enterprise. They could affect the entrepreneur subject to estate or inheritance taxes, and they could affect the decisions of heirs.
So is this tax an important source of revenue since the pros and cons balances it out?
National inheritance taxes exist in many countries such as the United Kingdom, Germany, Italy, Belgium, Ireland, France, the Czech Republic, Canada and some states in the US. The inherited wealth is defined as unearned income. It differs from wealth generated through thrift, enterprise or sheer hard work. So the ethical basis for taxing inherited wealth is quite distinctive.
The social equity argument is also strong. Inheritance perpetuates economic inequalities inter-generationally and therefore obstructs egalitarian ambitions. Income thereby begets wealth and wealth begets income. Taxing inherited wealth would create a less unequal distribution of income and produce a more “level playing field” within the society.
Even orthodox economists concede that there is a strong case for inheritance taxation. This is because it does not have the adverse economic consequences that they commonly say results from some other forms of taxation. Income received from inheritance is a windfall gain. It has no relationship to the economic efforts of the recipient/s. So inheritance tax is unlikely to adversely effects economic productivity.
Inheritance tax can also produce a good revenue stream for the government, taking the pressure off other forms of taxation and/or financing socially desirable government expenditures (such as public housing provision, the education of young people, child care services or hospitals). The amount of revenue that would be generated by a new tax on inherited wealth would depend on its precise form, of course.
New taxes, although never popular, can be made more palatable if they address major social problems and injustices. Political acceptability is also enhanced if there is a link between the tax revenue and specified socially desirable expenditure. Unequal societies tend to be unhappier societies. They generally have a higher incidence of mental and physical illness, violence, crime and incarceration. Taxing wealth inheritance does not solve all these stresses, of course, but it helps to create a sounder economic foundation.
In short, the theoretical effects of the inheritance tax on the whole remains unclear. They depend critically on the existence of a bequest motive. For many estates, bequests are essentially accidental - a consequence of saving against longevity risk (people do not want to run out of savings) and the risk of high expenses for medical care or long-term care combined with imperfect insurance markets, which make the cost of fully insuring against these risks appear prohibitive.
One need to look for evidence of unselfish intent. If parents care about the well-being of their children, then bequests should compensate heirs for differences in ability. The recipient of an inheritance might use an infusion of cash to fund a new business or expand an existing one.
Even if the link between inheritance-tax rates and inequality were clear, wealth can pay for a good tax lawyer. if governments impose a steep enough duty, the rich will find ways to avoid it. The trusts they create as a result can last even longer than the three generations it takes for family fortunes to go from clogs to clogs.
And a large inheritance-tax bill is destructive, because it can cause the dismemberment of family firms and farms, and force the sale of ancestral homes. The risks that heirs will be forced to sell homes and firms can be mitigated by allowing them to pay the duties gradually, from cashflow rather than by fire-sales.
Unlike capital-gains taxes, heavier estate taxes do not seem to dissuade saving or investment. Unlike sales taxes, they are progressive. To the extent that a higher inheritance tax can fund cuts to all other taxes, the system can be more efficient.
So, what is the right approach?
The right approach is to strike a balance. Question of the appropriate threshold is particularly important is this regard. There is a trade-off between politics and economics here - between the political acceptability to a broad “middle class” within the electorate and the economic goal of raising substantial tax revenue.
Three principles designed will stand out. First, target the wealthy; that means taxing inheritors rather than estates and setting a meaningful exemption threshold. Second, keep it simple. Close loopholes for those who are caught in the net by setting a flat rate and by giving people a lifetime allowance for bequests; set the rate high enough to raise significant sums, but not so high that it attracts massive avoidance. Third, with the fiscal headroom generated by higher inheritance tax, reduce other taxes, lightening the load for most people.
Anthony Dass is group chief economist, AmBank, and adjunct professor, faculty of economics, UNE, Australia.