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Children of the ultra-wealthy have opportunities that children born into poor families could never dream of. Access to the very best schools, a ready-made network of influential family friends, interest-free loans — all at their disposal just by virtue of birth. Should these fortunates also not have to pay taxes?
With the onslaught of inequality-increasing policy directives coming out of the White House these days, it’s easy to lose sight of what good policy ideas look like. Lily Batchelder, author of this just-published Democracy Journal article, refuses to let our bleak short-term political reality get in the way of advancing smart solutions to our growing wealth divide.
At the heart of Batchelder’s vision: a federal inheritance tax. She’s proposing this new levy to replace the current estate tax. Her inheritance tax would “simply require wealthy heirs to pay income tax on their large inheritances like all American workers pay tax on their earnings.”
The federal estate tax, a levy on the intergenerational transfer of immense wealth, first came on the scene a hundred years ago. The basic intent: to break up the wealth dynasties of the original Gilded Age. Over time, the ultra-wealthy and their lobbyists, accountants, and PR firms have whittled away at that goal. In 1972, estate tax revenue made up 2.6 percent of federal revenue. Today’s share: just 0.6 percent.
Inherited income, Batchelder notes, now stands “taxed at less than one-quarter of the rate on income from work and savings.”
The estate tax currently falls solely on the ultra-wealthy. Some 99.8 percent of the country will never pay a dime in estate taxes. Those individuals who will hold at least $5.5 million in assets, or $11 million for married couples. On paper, the wealthy face a 35 percent tax on these assets. In actual practice, they pay estate tax at a mere 16 percent rate, after manipulating a variety of complex tax avoidance schemes using trusts and other financial mechanisms.
Batchelder begins her case for fixing the estate tax by acknowledging the deep inequality in income, wealth, and opportunity that now exists in the United States. An American millionaire, on average, inherits ten times as much as someone earning the average income.
Among other industrialized nations, the United States has among the lowest levels of intergenerational economic mobility. In simple terms, that means children born to poor parents have little real chance at becoming rich — or even middle class.
Batchelder offers three solutions for reform, acknowledging that none of them will likely to make it into law any time soon.
The first — and most traditional — option: raise the estate tax rates, lower the exemption levels, and close the loopholes in the tax. Bernie Sanders has for years championed a Responsible Estate Tax act that would raise $235 billion over ten years in this fashion.
The second idea Batchelder offers: shut a little-known loophole in the tax code called “stepped-up basis.” She explains the concept succinctly:
Suppose, for example, that a father purchased stock decades ago for $10,000 that is now worth $10 million and leaves it to his son. Stepped-up basis means the son’s basis in the stock is “stepped up” to its current value, so neither the father nor his son ever pays tax on the capital gain of almost $10 million.
Barack Obama proposed eliminating stepped-up basis, a move that would generate $210 billion over 10 years, 99 percent of that coming from the top 1 percent. But Congress never gave that idea any attention.
Finally, Batchelder gets to her favored option: replacing the existing tax on the estates the wealthy leave behind at death with a tax directly on the income that wealthy heirs inherit. Batchelder envisions heirs paying the regular income tax rate, plus a 15 percent surtax, on inherited wealth greater than a $2.1 million. [pullquote]Taxing an heir like Paris Hilton on her unearned income instead of Conrad Hilton, the person who created the family fortune, will strike most people as eminently fair and sensible.[/pullquote]
“Even with the surcharge,” Batchelder argues, “wealthy heirs would still typically pay a lower rate of tax on their inherited income than workers pay on a similar amount of labor income because of the large exemption, which workers cannot claim on their wages.”
For folks who don’t work as tax attorneys, the distinction between an estate tax and an inheritance tax can seem too subtle to matter much. But this distinction can have huge implications.
On a rhetorical level, an inheritance tax has the advantage of “better aligning public understanding of wealth transfer taxes” with their actual economic effects. In other words, taxing an heir like Paris Hilton on her unearned income instead of Conrad Hilton, the person who created the family fortune, will strike most people as eminently fair and sensible.
Batchelder’s proposal reminds us that good policy ideas still have an important place in our political discourse, despite the current political balance of power in Washington. If you’re looking for a “society where our children’s economic futures are determined more by their dreams and the strength of their effort than by whether they were lucky enough to come from extraordinary wealth,” give this essay your time and consideration.
Josh Hoxie directs the Project on Taxation and Opportunity at the Institute for Policy Studies.