Death and Taxes

Inheritance tax is the tax that seemingly everyone hates. Wherever you look, you cannot find a politician who argues for it. They all seem to be outdoing each other with promises to cut it or scrap it altogether. Perhaps they are just trying to please voters. The e-petition to scrap inheritance tax was the fourth most popular petition since the UK government introduced e-petitions. A total of 128,622 people clicked their mouse button to have their say. With the whole world seemingly against inheritance tax, apart from a few notable exceptions that I will come to later, I guess it is up to people like me to make the argument for increasing it.

The economic arguments behind cutting taxes are pretty straightforward. If you cut taxes, you give people more incentive to work. They then work harder, are more productive, earn more, and generate more total tax anyhow. Hence you can get a virtuous circle and still be able to pay for welfare and wars and all those other things you need the state for. Generally, cutting taxes is seen as a way to stimulate economies. Now, if there is one tax cut that will not stimulate the economy, it has to be an inheritance tax cut. When it comes to money and death, you cannot take it with you. The incentive to work hard and make money is generally going to be higher if you are intending to spend that money on yourself, rather than on hoarding it and distributing it in your will. People, of course, want to leave their worldly possessions to their offspring. Nothing wrong with that, but then there is nothing wrong with giving your offspring gifts whilst you are alive. If people opt to hold on to their wealth until their dying day, that rather clarifies who is their number one priority, no matter how much sentimental humbug we might have for the deceased. If you are thinking ahead to the day you die, there is no harm in spreading your possessions well before that day, in which case inheritance tax should make no impact on your attitude to work and to making money. If you are not thinking ahead to the day you die, then you are not thinking about inheritance tax either, so the rate of inheritance tax would be irrelevant when it comes to motivating you to work. Whatever logic we apply to taxes on the living, we should reverse for the dead. Taxing inheritances does not disincentivize the dead, but not taxing inheritances can disincentivize the living. Why work, if you can just live off the accumulated wealth of your forebears? Or, if you still have to work, an inheritance at least means you do not have to work as hard as you might to get the standard of living you enjoy. If you decrease inheritance tax, and increase taxes on the living to compensate, you just encourage the people waiting for a payout to do just that – they will wait, instead of working hard and making their own way in life. In contrast, higher employment taxes will discourage the people who start with nothing and have to work their way up.

One current debating point is that, because of house price rises, inheritance tax is immoral. The basis of this argument is that people will have to sell the family home to pay for the inheritance tax when the owner dies. Excuse me if my heart does not bleed profusely at the thought. So someone inherits a big valuable asset, the value of which has grown greatly in the last few decades because of economic factors and not because of hard work. They then sell it off, pay a tax bill, and get to keep the rest. What is so immoral about that? Compare that fate to those of people who cannot afford to buy a house, as a result of the disproportionate growth in house prices, because they have no inheritance, and because the supply of houses is limited by profiteering builders and endless nimby planning restrictions. Then tell me which is the more immoral. Put simply, the trend is for fewer and fewer people to live in each house. Houses that could accommodate families are increasingly being owned and lived in by old people, often alone. Where does it say that it is morally necessary that these houses be gifted, free of tax, in their wills? Presumably then the benefactors can choose either to live in the house, or put it on the market to make the most money they can. Hmmm. None of this helps liquidity in the housing market. First-time buyers would be much better off if more houses were on the market, and sellers were keen because they had to settle a big tax bill. Instead of reducing inheritance tax, and assisting the better-off in keeping an economic advantage created by the uneven distribution of housing wealth, increasing inheritance tax would help first-time buyers – people who are working hard and want a home to raise a family – by putting more housing stock on the market at more realistic prices.

Another argument is that inheritance tax is a double tax, and hence wrong. Hmmm. Governments say they do not tax you twice, but they do all the time. Why inheritance tax should be an exception I do not know. For example, you make money, get taxed, spend money, get taxed. That looks like double taxation to me. You make money, get taxed, buy a valuable asset and give it to your kids. Guess what? There is capital gains tax on the gift. If anything, inheritance tax is the only tax that is definitely not double taxation. You make some money and get taxed, then you die and your kids get taxed. That makes it the only tax where you can be sure the same person is not being stung twice.

If you ask you a silly question, you generally get a silly answer. The funny thing is that people cannot tell which questions are silly, unless you make it obvious. Here are some examples. If you ask people whether taxes should be lowered, they will agree. If you ask people if governments should spend more on services, they will agree. And if you ask people if governments should balance budgets and not rely on borrowing, they will agree. Hmmm. We do not know how the aforementioned petitioners intended to offset the loss in tax income caused by scrapping inheritance tax. Rather unhelpfully, they were silent on that topic. Let us assume that they would make up the shortfall by increasing taxes elsewhere. So let us be clear on this – reducing inheritance tax is the same as making it harder for poor people to earn more and get on in life. If you start poor, inheritance tax is irrelevant. What is relevant is the taxes you pay on the work that you do. So scrapping inheritance tax, if balanced by an increase in other taxes, would reduce social mobility. It would help to keep the wealthier wealthier and the poorer poorer. It shifts the tax burden away from people who inherit wealth they did not work for, and on to people who do not inherit wealth and pay taxes on their earnings and consumption. So I can understand why the economic conservatives like the idea, but I am confused why so many lefties favour a reduction in inheritance tax. The only possible explanation is that they think it will win votes and they can just borrow some money to make up the shortfall in government finances. That way everybody wins… apart from the great-grandchildren who will still have to service the debt. Presumably the great-grandchildren who did not inherit from their parents who did not inherit from their parents who did not inherit from their parents will still be the ones bearing a higher share of the tax burden. But then, today’s politicians will be dead by then, and hence long past caring about their political inheritance…

Ah yes, think of the children. That is what the argument about inheritance tax is about, is it not? Think of your children. Your right to give them your belongings, without the horrid state interfering… Well, think about that for a moment. Which is better, that your inheritance get taxed, or their earnings get taxed? If the total taxation take by government is the same, I say tax the inheritance. At least then children will grow up with a better chance of understanding that rewards should come from hard work, and not from accidents of birth. They might well have the motivation to do more in life. Most importantly, the hard workers will be better off. If your children work hard, and earn a lot, they would be better off with a smaller inheritance and keeping more of their earnings. On the other hand, if your children are lazy, they would be better off keeping a larger share of the inheritance and paying more tax on their earnings. So those petitioners who want to scrap inheritance tax are saying, in a roundabout way, that they think their children are lazy and would be better off with higher taxes on their earnings than on their unearned inheritance. How about that for a vote of no confidence in their own parenting skills!

Truth is, no matter how you cut the tax pie, if the total size of the pie is to stay the same, then the only decision is who will be better off and who worse off. Reducing inheritance tax ultimately helps the richer and not the poorer. If you then have income tax rules aimed at not squeezing people at the bottom, guess who gets squeezed? The people in the middle. A lot of middle earners are swallowing, and talking, a lot of bull about inheritance tax hurting them. Hmmm. So how does a modest one-off reduction to the middle earners, and a large reduction to the top tax payers make the world a better place for middle earners? It does not. In fact, it makes it worse. Consider where the money is going to come from to make up the tax shortfall. Probably not from the very poorest, who will suffer a smaller burden anyhow. Not the richest – any clever argument that the rich benefit from tax planning to avoid inheritance tax can just as well be applied to each and every tax. Nope, the people who will pay more are the ones in the middle. Cutting inheritance tax may make the rich better off, but the middle will only end up coughing up more cash in other taxes to more than make up for any benefit they gain. The irony here is that a vote-pleaser with the middle income bracket will probably hurt them most in the long run, as they will receive much smaller benefits than the rich, and they will carry a greater burden of the income taxes that would have to go up to compensate.

One last thought about children and inheritance tax. It seems governments are increasingly falling over themselves to be seen as the providers for families and children. Flexible work hours, family tax credits, parental leave from work, better investment in schools as well as healthcare for children … all great for people who receive the benefits. Also increasingly irritating for the childless singletons who find themselves having to subsidize it all. Family-friendly political policies may ultimately be the surest way of undermining the family as the cornerstone of our society. Subsidies make it easier for the reckless to fund and manage a family. In contrast, an increased burden on those without children penalizes those people who take a responsible attitude and want to be financially secure before bringing children into this world. In the end, the responsible people will be paying more tax whilst they are saving for their own families, in order to subsidize the irresponsible families that will be at greatest danger, and hence will be loudest in demanding more assistance, if there is a severe economic downturn. The risks of making the most responsible people work ever harder in order to save for a house and family seems not to have dawned on most politicians. My point here is about who benefits from lower inheritance tax must be seen in the context of overall changes that help to shape our society. The immediate beneficiaries of reduced inheritance tax would be the children of those who already have wealth. Combined with other factors, it will help accelerate the trend towards a two-speed society and two-speed economy. On one side, we will have a hard working, high taxed, joyless economy for singletons, especially if they start poor, have no inheritance, and intend to save to get on the housing ladder and have children of their own. On the other side, we will have families that enjoy quality time, low tax, and a family-friendly economy. They will have children. They will be subsidized, even if they start wealthy and inherit a house suitable to raise a family (maybe used to raise their own, or maybe just rented out to make money from somebody else). The poor will be subsidized even more if they have a family, but the subsidy will not be enough to close the gap to the better off. However, the subsidy may be enough to make them better off than their peers who decided to work and save before having a family. This looks to me like the construction of a sophisticated but damning poverty trap, where the poor are better off with families and part-time work than without families and in full-time work. The only people who really lose out are the ones who start poor and work hard to better themselves – they will bear the brunt of having to subsidize others. They will be working the long hours whilst others leave early or have career breaks to raise kids. They will generate the tax income to pay for health and education services. They will pay a disproportionate level of tax relative to their earnings, and not receive benefits. And because they started out with no inheritance, reducing or scrapping inheritance tax is of no benefit to them. In fact, it penalizes them even further, as they end up paying more tax on their earnings to compensate for the loss in tax revenues.

Just as tax cannot be divorced from spending or borrowing, so the impact of a change in inheritance tax should not be considered separately from the impact of other policies towards taxation and spending. They all help to determine the nature of our society. At present, the forces all seem to pushing the same way, and when that happens you may have one section of society of happier, but only by punishing the losers. Hopefully even the most arrogant of tinkering politicians can now see what happens if you constantly rob Peter to pay Paul. What irks me is that so many are agreed on who the winners should be, and hence who will be the losers by default, that nobody seems to have noticed that the losers may very well be the people who most deserve to be helped and rewarded if society wants to encourage family values and economic productivity.

Can 128,622 people who sign a petition be wrong? Of course! For every 128,622 who sees no contradiction in wanting lower taxes, higher spending, and a balanced government budget, you can probably find one person who talks some sense. Warren Buffett is by any measure a very wealthy man. From time to time, on some lists, he is stated to be the wealthiest man. For example, Forbes says he is worth US$62bn. Yet Buffett believes in taxing the rich Americans more, and the poor Americans less, and that death taxes are a key vehicle for achieving that goal. Buffett spoke with wit and venom on the topic when he attended the Senate hearings considering the reduction or removal of the American estate tax. You can see the video and read the transcript of what Buffett said to the Senate hearing here. For context, you can see the full video of the hearing here. Back in 1986, Buffett gave an interview to Fortune Magazine where he stated his attitude to the inheritance he would give his children.

Twenty years hence, Buffett is still going strong, but is a man of his word; he has made plans to leave the vast bulk of his wealth to charity, mostly through the charitable foundation set up by Bill and Melinda Gates. His children profess they have been happy that their father has set them such a good example. Nobody can be quite sure what he has left them. However, all the indications from their lifestyle are that it is in line, allowing for inflation, with what he said in 1986. Back then he suggested that an inheritance of a few hundred thousand dollars would be sufficient, including the cost of a college education. That puts our petitioners into perspective. The inheritance tax rules in the UK were changed in 2007 to give an effective threshold of UK£300,000 for singletons, and UK£600,000 for couples. Per my rough calculations for inflations and exchange rates, Buffett’s few hundred thousand dollars in 1986 would be approximately equal to a few hundred thousand pounds today. So by Buffett’s standards, it looks like the British tax code is now lenient enough to result in no tax penalties for the kind of inheritance that Buffett will leave for his children. If that is enough for the children of the richest man on the planet, I struggle to sympathize with the arguments of the petitioners who want to scrap the tax completely, but do not offer any explanation for who will make up the shortfall. For me, the equation is simple. Tax the dead, and not the living, if you want people to work for the future, and not live off the past.