Tax Notes Talk podcast is a weekly discussion of cutting-edge developments in tax, including up-to-the-minute changes in federal, state, and international tax law and regulations. You can listen to Tax Notes Talk on iTunes, Spotify, Google Play and on the Tax Notes website.
The podcast episode’s transcript below has been edited for length and clarity.
Getty
In this episode, Joseph Thorndike, director of the Tax History Project at Tax Analysts, explains the history of estate and inheritance taxes and how they became so unpopular.
David Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: death taxes. The estate tax, the inheritance tax, the death tax — whatever you call it, it’s controversial, but very few people pay it. Here to talk about what it is and the perceptions around it is the director of the Tax History Project and Tax Notes contributing editor Joseph Thorndike. Joe, welcome to the podcast.
Joe Thorndike: Hey. It’s great to be here.
David Stewart: Let’s start off with terminology. There are many different names around the same concept. Has it always been called the death tax? Is that kind of a loaded phrase?
Joe Thorndike: Oddly, it has always been called the death tax. People used to call all sorts of taxes death taxes. They would call the federal estate tax a death tax. They called state inheritance taxes a death tax. They would call any kind of a transfer tax that is occasioned by death a death tax. It’s interesting that we now see this as a way to attack the tax, but it used to be just considered descriptive, because it is tied to the event of death.
David Stewart: Is there a difference between an inheritance tax and an estate tax?
Joe Thorndike: An estate tax is levied on the big bulk of an estate that a dead person leaves behind before it’s distributed to all the beneficiaries of that estate. An inheritance tax, by contrast — and these are used by the states principally — is levied on that distributive share of the larger estate that goes to an individual person.
David Stewart: Let’s talk a little bit more about what this really is. Is this a tax on death or is it a tax on something else? What are we really taxing when we do an estate tax, inheritance tax, etc.?
Joe Thorndike: You don’t exactly get in trouble for dying, right? You’re not actually taxing the fact that you died. But it is occasioned by the fact that you die and you then want to transfer some assets to the people you leave behind. Tax people like to call it a transfer tax because it’s taxing that right to make a transfer. Now this starts to quickly get into the politics side of it because a lot of people think that the right to transfer assets to your children, for instance, is not something that government has and then chooses to give you. But it is a tax on the right to transfer wealth after death.
David Stewart: There’s been a lot of changes over the last several years in the U.S. tax system. How does it function today?
Joe Thorndike: Basically, it applies to the transfer of any sort of assets — like cash or real estate or stock — but only on really big estates. The exemption is $11.2 million for a single person. For couples, that means that you can transfer $22.4 million to your heirs and not owe any estate tax on it. This means that very few people actually end up paying the tax. The top 10 percent of income earners — I’m just using income earners as sort of a proxy for rich people — pay more than 90 percent of the estate tax. Almost 40 percent is paid by just the richest 0.1 percent of income earners. There really aren’t many family farms or small businesses in this grouping. I think there are about 4,000 estate tax returns in our most recent numbers for people who died in 2018. Only about 1,900 are taxable. That’s less than 0.1 percent of the 2.8 million people expected to die that year. Another way to think about this is 99.94 percent of estates are exempt.
David Stewart: How much money are we talking about raising here?
Joe Thorndike: It’s not nothing, but it’s not a big-ticket item anymore. That’s partly because we’ve raised the exemption so high. The tax raised about $15 billion in 2018. That’s less than 1 percent of total federal revenue. It’s not going to pay for a whole lot. It’s not going to break the bank if we don’t have it. The point of it right now is not really a revenue argument so much at this time as it is a fairness argument.
David Stewart: You mentioned that this isn’t really catching the family farm. Who does it really catch?
Joe Thorndike: It catches really rich people. The question then becomes whether it even catches them very well because there are avoidance techniques for the estate tax. It used to be said that it was an optional tax because anyone who did enough tax planning could avoid it. I don’t want to say it’s a tax on plutocrats, but it’s a tax on the extremely rich, not just the very rich.
Miniature people standing on a pile of coins.
David Stewart: Let’s turn to the history of this tax. How long have these taxes been around?
Joe Thorndike: Honestly, people have been trying to tax death or tax events around death for about as long as they’ve been taxing anything. You can find them in death-related texts in ancient Egypt and ancient Rome. European history is filled with them. As soon as there are taxes being collected by modern states, they’re pretty much collecting some kind of death-related tax. But let’s bring it a little closer to home, to the U.S. The U.S. starts really early with a version of the estate tax. They have one in 1797 to help fund what they called the Quasi-War with France. We never actually got in a war with France, but we were sort of shooting each other’s ships and they needed to find a way to pay for that. It disappears and then it comes back during the Civil War to help pay for that war. That’s in 1862, it lasts until 1872, and then it goes away again because people don’t like it. It comes back in 1898 because they need to fund another war. The storyline here – at least in these early years – is that it’s a war tax. Most taxes are war taxes in the early period of American history. Most of them are levied and then repealed later, and it’s fair to look at the estate tax as that – an emergency tax. But that all changes in 1916 when Congress for the first time levies an estate tax that it plans on keeping around for a long time.
David Stewart: This sort of coincides with the income tax coming in permanently?
Joe Thorndike: Yes. There’s basically a broader revolution going on at the time in the way people think about tax. Until then, they’re raising all the federal revenue pretty much with tariff duties, which are newly popular again. They were also a couple of excise taxes on things like alcohol and tobacco, but people thought, “This is really regressive. These sorts of taxes fall heavily on poor people, so what we need are some taxes to fall on rich people.” From the beginning, talk about creating a new federal income tax generally included talk about creating a new estate tax. In 1894, they enact an income tax and no estate tax because they decided to treat estates as regular income. That income tax doesn’t go anywhere. But in 1913, we famously get this federal income tax that sticks around and soon after they create an estate tax in 1916. The question really is what were they trying to accomplish? There was a lot of talk about growing inequality, how it was unfair and dangerous, and threatened the body politic. Were they planning on using the estate tax to get rid of some of this inequality? To redistribute this wealth that was going to a few super rich people and give it to everybody else? The short answer is not really. There were definitely some people who were interested in that, but for the most part, they were interested in redistributing the tax burden.
David Stewart: Let’s fast forward into more recent history. There seems to have been a lot of opposition to the estate tax. What’s been happening?
Joe Thorndike: It’s easy to tell the middle part of this story because it’s not very exciting. They create the estate tax. It’s relatively uncontroversial. There’s a move during the New Deal era when former President Franklin Roosevelt says, “Great accumulations of wealth can’t be justified on the basis of personal and family security,” but nothing happens. They don’t really change the estate tax system and instead it just chugs along. It doesn’t attract lots of hostility from conservatives, but one thing that also doesn’t happen is that they don’t really modernize it very well. The exemption, which is the size of the estate exempt from tax, doesn’t change from 1942 to 1976. It stays at $60,000. Well, a lot of things changed between 1942 and 1976, including the value of $60,000. By sort of not paying enough attention to the estate tax — not modernizing it, not keeping up with the changes in the economy — the estate tax got a little out of whack. When it was first created, the exemptions were designed to really hit only very rich people. But as the exemption remained in place and inflation continued, it started to erode the value of that. Suddenly the estate taxes taxing really rich people is also starting to reach into the upper middle class, too. In the 1990s, you see a growing movement to get rid of this tax or at least to gut it.
David Stewart: Turning to this century, there was a brief period where it just disappeared entirely for a year?
Joe Thorndike: Yes. In 2001, the great accomplishment of this anti-death tax movement is they actually repeal the estate tax, but they put it off for a bunch of years. They said, “We’re going to gradually get rid of it and then it’ll be gone.” It was saved from death at the last minute when they had to do this with a lot of the so-called Bush tax cuts enacted during the George W. Bush presidency. The estate tax was saved, but it did disappear for one year and then they sort of reached back and recreated it. The death tax was saved from death.
David Stewart: Why is the estate tax so unpopular?
Joe Thorndike: Right? Because why should it be unpopular? It doesn’t really make any sense because this tax polls very badly and yet no one actually pays it. Steven Sheffrin, who wrote the book Tax Fairness and Folk Justice, which tries to tease out what about the estate tax makes it so unpopular. I think it’s this idea that the tax is tied to death, which awakens fears and anxieties, but it’s also tied very closely to the idea of family obligation. A lot of people don’t like this idea that the estate tax gets in the way of providing for your children. The estate tax seems to threaten that. I don’t think anyone has the definitive answer on why the estate tax is unpopular. Some people think everyone worries that they’re going to pay it someday, but that doesn’t seem plausible to me. It seems much more likely that the tax itself, because it’s structured around the death of an individual and then what is done with the assets as they pass to the next generation, that offends the sensibilities of a lot of voters. Many of them feel that the right to pass wealth to your children is sort of a God-given right that shouldn’t be regulated by the government. By comparison, a wealth tax polls very well. Why is it that a wealth tax does so well when the estate tax does so poorly? I think there are reasons for both sides to be concerned. Supporters of a wealth tax shouldn’t be so quick to assume that their tax will stay popular because the estate tax looks a lot like a wealth tax. But it’s also true that these supporters of a wealth tax may be on to something, that the tax might be different enough from the estate tax that it will remain popular. I think this is sort of the modern salience of this issue that we’re trying to sort out.
David Stewart: You say that an estate tax is sort of like a wealth tax. How does it function like wealth tax?
Joe Thorndike: It’s more in sort of intentionality. They are both driven by a concern about inequality. They’re both driven by a concern about the fairness and allocation of the tax burden. And both of them go after big accumulations of wealth and try to do something with them. Now, a wealth tax taxes a big chunk of wealth every year at a very small rate that tends to raise a lot of money over time. Meanwhile, the estate tax walks in and takes 40 percent of everything above the exemption all at once. Both of them are targeting the same sorts of people — rich people. They’re targeting accumulations of wealth. Well, wealth taxes are meant to do something about that, and so are estate taxes. They function very differently. One happens once. Wealth taxes happen every year, but they are both driven by the same impulses.
David Stewart: Let’s say a policymaker is being driven by those same impulses and wants to find a way of taxing wealth other than an estate tax or a wealth tax. Are there other options?
Joe Thorndike: Yes. There are easier ways to go after these accumulations of wealth than a new wealth tax or even a very unpopular estate tax, although some of them would work in conjunction with the estate tax. For instance, you can raise marginal rates on income. It doesn’t directly resolve this problem of large accumulations of wealth and take them apart, but it does it in sort of piecemeal fashion. You can also tax capital gains like regular income. Right now, capital gains get taxed at a preferential rate. That has almost always been the case in American tax policy. If you were to decide to tax capital gains just like regular income, that would hit a lot of the same people — those who own lots of stock, lots of assets that appreciate over time. The last one — and this would sort of work in conjunction with the estate tax — is through the stepped-up basis. When a person dies now and hands over a house to their child, the child’s basis in that house, so for tax purposes that’s half the calculation when you’re trying to figure out what kind of tax you owe, you’re going to get a stepped-up basis. That means the value of that house for tax purposes is going to be what it was when you received it. This is a somewhat of a complicated topic for non-tax people. It’s certainly hard to put together a soundbite around stepped-up basis and why it allows people to avoid taxes, but you could do a lot to reduce these large accumulations of wealth by simply saying you’re not going to get a stepped-up basis. I think that strikes me as something that might actually happen partly because people don’t understand it all that well. A stepped-up basis might just be wonky enough that it won’t actually catch the same kind of political flack.
David Stewart: Well, Joe. This has been fascinating. Thank you for being here.
Joe Thorndike: It’s my pleasure. Always enjoy it.