Optimal Inheritance Tax Rates: Conservative Heads Exploding Edition

Barnabas Collins Is Displeased With The Optimal Tax Rates!

When you hear conservatives talk about inheritance taxes, they invariably refer to them as “death” taxes.  And like any tax, they want to eliminate this one too.  Never mind that labeling it a “death” tax is, of course, absurd on its face.  It’s not a tax on death, it’s a tax on inheritance.  Inheritance is unearned income for the person receiving it and should be subject to tax like any other income.

While it may seem perverse to tax one person’s earnings twice, a key feature of inherited wealth is that upon transfer it goes from being one person’s income to another’s. There is nothing unreasonable then, about asking the person who receives an inheritance to pay their fair share on their new income — particularly when all other earners, including minimum wage workers, pay taxes on the very first dollar they earn. To discuss whether to increase the size of estates exempted from taxation to $3 million, $10 million, or to make it unlimited is to move in the wrong direction in a society that values hard work. The current favorable treatment of inherited versus earned income is the opposite of what it should be.

So why am I talking about this now?  Because economist Brad DeLong pointed me to a paper which proposes an optimal results based analysis of intragenerational wealth transfer, something I’ve been curious about for a long time.  And the results are as I expected.  Everything the GOP is talking about is wrong.  Completely, totally, belly-laughingly wrong.  Big surprise, huh?

The paper, by  Thomas Piketty, Paris School of Economics and Emmanuel Saez, UC Berkeley and NBER, entitled A Theory of Optimal Capital Taxation was published back in 2011.  It outlines a normative approach to identifying the optimal tax rates for inheritance.

For realistic parameters, the optimal linear inheritance tax rate should be as high as 50% – 60% if the government has meritocratic preferences (i.e., puts higher welfare weights on those with little inheritance). Because real world inherited wealth is highly concentrated (basically half of the population receives close to zero bequest), our results are very robust to reasonable changes in the social welfare objective. I.e. the optimal tax policy from the viewpoint of those receiving zero bequest is very close to the welfare optimum for bottom 50% bequest receivers.

But the authors recommend a higher level for top capital transfers.

For top bequests, the optimal inheritance tax rate can be even larger (say, 70% –  80%), especially if bequest are are large, and if the probability of bottom receivers to leave a large bequest is small. Therefore our normative model can account for the relatively large bequest tax rates observed in most advanced economies during the past 100 years, especially in Anglo-Saxon countries between the 1930s and the 1980s.

Once again, the world is a very different place than Republicans think it is…. Can you hear the dominoes falling?

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