(Bloomberg View) — One has to marvel at the politics of the estate tax. I generally believe that people don’t care about taxes, as long as someone else is paying them. The estate tax defies that belief. I also generally believe that policies with negligible cost and negligible benefit — especially those that affect almost no one — are unlikely to stir the hearts of the electorate. Which is true. Except for the estate tax.
Why does it get people fired up?
For political points. Democrats spend a great deal of time fulminating about a tax that raises roughly no revenue for the Treasury. This is not the only such inconsequential policy they care about, mind you; President Obama’s obsession with changing the depreciation schedule for corporate jets springs readily to mind. But Obama is a politician, and politicians are always happy when they can find some complete nonissue that sounds like “tax breaks for corporate jets” and prate about it on the stump to an electorate that doesn’t know fancy words like “depreciation schedule” and isn’t going to bother to learn them. Even leftish policy wonks sort of roll their eyes at the sordid necessities of politics, and move on to more important matters. But not with the estate tax. About the estate tax, left-wing wonks care.
Then you have the Republicans. I understand why Republicans are so gung ho to get rid of the estate tax: Simply put, very rich people will donate a lot of money to campaigns that suggest their children ought to be able to inherit their wealth tax-free. What is astonishing to me is how successfully Republicans have been able to rebrand the estate tax as the “death tax,” and persuade 71% of voters that inheritance taxes are unfair. Now, if the estate tax were actually widely paid, and stood in the way of ordinary Americans inheriting Grandma’s mint-condition 1984 Cadillac Eldorado, this would not be at all surprising. But only a tiny percentage of estates pay the tax, because you get to pass on more than $5 million tax-free before the government takes a dime (more for couples).
Another mystery: Why do Democratic policy wonks care whether the right abolishes the tax?
In fact, there are reasons to keep the estate tax around. Let’s start with some basic moral observations: Once you are dead, you no longer have a voting interest in what goes on in society. Thus, your interest in how your assets get disposed of after you’re no longer using them is minimal. While you’re alive, I’ll defend your property rights vigorously. Once you have died, however, you lose my support.
Now I’ll add another proposition: Society does not have an interest in your desire to ensure that your children are better off than other children. I understand that you have a great interest in this matter. I applaud the tireless work you put in to this end. But society’s job is all children, not specific children who are lucky enough to have hit the genetic lottery. And its aim should be for a society of equal opportunity to succeed and get rich. So once you’ve died, and no longer have property rights society needs to protect, there’s no particular moral precept that points toward helping your children inherit. On a moral level, I’d be perfectly comfortable with a 100% tax on anything you haven’t passed on before your death.
Now we’ll add in a policy reason for the estate tax: Without it, inheritance becomes a mass tax-avoidance scheme. While the owners were living, their assets piled up capital gains. If they’d sold them while they were alive, they’d have to pay taxes on those gains. But when people die, the estate system does something called “stepping up the basis” of those assets, which in plain English, means that the assets are revalued to today’s price, so that when the heirs sell them, they only have to pay the difference between the asset’s value when they inherited, and the asset’s value when they sell. Since today’s value is generally higher than it was whenever Grandma bought that stock, painting, or piece of land, this is a very valuable bit of tax avoidance.
So society has a right and a reason to tax estates.
Of course, there are also reasons to be modest in our estate-taxing ambitions (and the U.S. certainly is, which is one reason that so few estates pay it). People will work hard to pass on their wealth to their children, and that work has spillover benefits for the rest of us. A lot of rich folks are doing unglamorous things like running fast-food-franchise operations, building homes, and manufacturing plumbing supplies. As they near their golden years, those folks might well be tempted to slack off if they knew that any further work would benefit strangers instead of their children.
Properly modest inheritance-taxing ambitions don’t have to take the form of an estate tax. We could get rid of the estate tax if we also got rid of the basis step-up. The step-up made sense in the days when ownership records often consisted of little pieces of paper that Grandma had lying around in her attic from who-knows-when. But major financial assets like land, securities and often even art now have good, easily accessible records of who purchased them and when. We could improve the quality of record-keeping by putting the burden on the inheritor: “Don’t have a record? Too bad, you’ll be taxed on this $1 million painting as though Grandma paid $0.”
Or we could keep the somewhat illogical system we have. What we shouldn’t do is follow the Republican plan of making large tax-free gifts to the children of very rich people. Or, for that matter, the Democratic plan of getting hysterical about the estate tax all out of proportion to its actual importance.
— Read How to Avoid Extra Taxes When Clients Avoid Marriage on ThinkAdvisor.