Taxing wealthy heirs could be an easy and harmless way to raise revenue.
Americans tend to think that a person is entitled to the money she earns.
Inherited wealth, however, has long been held in lower esteem by the voting public. In a country that has long defined itself in opposition to rigid class structures that large intergenerational bequests can promote, federal inheritance taxes have been levied intermittently in the U.S. since the 1790s, and estate tax rates have often been much higher than those levied on ordinary income.
In recent years, however, there has been a concerted effort to repeal these types of taxes, and the estate tax was temporarily eliminated in 2010 as part of the George W. Bush era tax cuts enacted in the early part of the last decade. In a column in the New York Times Saturday, former Bush economic advisor Gregory Mankiw laid out the logic against higher inheritance taxes:
From a policy perspective, we need to consider not only the direct effects on the family but also the indirect effects on the broader economy. Rising income inequality over the past several decades has meant meager growth in living standards for those near the bottom of the economic ladder, and one might worry that inherited wealth makes things worse. Yet standard economic analysis suggests otherwise.
When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers.
Because capital is subject to diminishing returns, an increase in its supply causes each unit of capital to earn less. And because increased capital raises labor productivity, workers enjoy higher wages. In other words, by saving rather than spending, those who leave an estate to their heirs induce an unintended redistribution of income from other owners of capital toward workers.
So, taxing inheritances lightly encourages rich people to invest more in their businesses, which in turn makes workers more valuable by making them more productive, increasing wages along the way. Considering the fact that one of the main problems facing the U.S. economy since the financial crisis has been a lack of investment on the part of businesses, it might then make sense to lower the taxes on estates in order to encourage this kind of investment.
There are, however, two problems with this analysis. One is that it’s not clear that higher taxes on bequests actually discourages business owners from investing in their businesses. A Congressional Budget Office report on the estate tax points to surveys that show that people don’t save primarily in order to pass along wealth to descendants and that many taxpayers don’t maximize their use of estate tax loopholes.
Also, the evidence doesn’t entirely support the idea that policies that encourage businesses to invest more will actually help the average worker. This chart from the Economic Policy Institute shows how worker productivity–which increases when firms invest in equipment that makes workers efficient–has diverged from median pay.
As you can see, over the past 30 years, the growth in productivity and wages have decoupled, giving the middle class voter much less reason to care about whether the wealthy are encouraged to invest in their businesses through the tax code.
Though it’s unlikely that revisions to the estate tax will be enacted in the near future given the political gridlock in Washington, calling for an increase in the estate tax to fund infrastructure or education could be a winning issue for a Democrat seeking the presidential nomination in 2016.
Hillary Clinton, the presumptive favorite in that race, has recently come under fire for engaging in (legal) tactics that would lower the amount of estate tax she and her husband would owe at the time of their deaths. Campaigning for a boost to the estate tax rate would bolster Clinton’s reputation as a politician fighting for the middle class at the expense of the rich.