A Conservative Argument for the Estate Tax

On this “Giving Tuesday,” Mark Zuckerberg announced in a public letter to his just-born daughter that he and his wife would be donating 99% of their Facebook stock. The gift is aimed at advancing “human potential and promote equality for all children in the next generation.” This gift is a massive commitment of $45 billion (at Facebook’s current share price) that has the potential to truly better the world. Don’t feel too badly for their daughter, Max, who is still in-line to get about $450 million (at today’s market price), or about 2x Mitt Romney’s net worth.

In light of Zuckerberg’s action, it seemed pertinent to briefly discuss the estate tax, and why I actually think conservatives should support it (despite deftly dubbing it the “death tax”) as I have alluded to in the past. My view is admittedly out of the orthodoxy and runs counter to our slate of Republican Presidential contenders who want to eliminate the tax.

Briefly before delving into my argument, I would emphasize my support for an estate tax in principle and not for our idiotically concocted one. Under current law, all estates beyond $5.4 million pay the same marginal tax rate of 40%. A small business owner with $30 million faces the same marginal rate as Warren Buffett, which is absurd. A primary concern of mine (and all conservatives…hopefully) is the ability of the super-wealthy to maintain their status for generations, which cannot be done at $30 million but can be at $30 billion. That small business owner or farmer also likely has less liquid wealth, and heirs could be forced to sell to pay the taxman, which argues for a lower initial rate. For illustrative purposes, I would propose a progressive estate tax of perhaps 15% for $5-15 million, 25% for $15-25 million, 35% for $25-$50 million, 50% for $50-$250 million, and 70% for $250 million and higher. I would also allow one’s tax burden to be nullified by charitable donations. That would mean the Zuckerberg estate would face no estate tax liability as it is donating over 70% to charity.

 

  1. Tax Code Efficiency

As some government spending is required and 100% debt funding is unsustainable, we have to tax. The conversation turns to how much we have to tax (dependent on how much we spend) and how we structure our tax code to generate the requisite revenue. Some liberals have this fixation on a “fair” tax code with no discernible definition of fairness. Conservatives focus on an efficient tax code, which is to say the code that has the least retardant impact on growth. Such a tax code would allow the economy to perform the best, all else equal, and help the poor and middle class improve their standing and their standard of living.

This requires taxing the least productive segments the most and most productive the least. Plus as we need to generate a certain amount of revenue, the decision to tax one party is in a sense a decision to not tax another (dynamic scoring adjusted). The estate tax generates about $20 billion in revenue per year or less than 1% of total federal revenue, so it isn’t particularly big (though I would put forth that $20 billion is still a lot of money, call me old-fashioned). If we want to generate the same aggregate revenue, we would have to increase other taxes by that $20 billion. One could argue income and corporate taxes are on today’s productivity whereas an estate tax is on the accumulated productivity of the past. Which tax would appear to drag on economic growth more?

From a different perspective, the estate tax in a sense takes money away from the ensuing generations (the heirs), and as I explain in point 2, it is very uncertain they will use the funds in a productive fashion whereas income is more clearly associated with productivity. Whom would you rather tax if you want a tax code that is likely to impact productivity the least? While there are individual exceptions no doubt, in aggregate, the estate tax targets less productive capital (from either vantage point), meaning we can tax more productive capital and labor less (to the tune of about $20 billion/year), which at the margins should support growth. (In full disclosure, I would note the Tax Foundation seems to disagree with me, though I would suggest it overstates the productivity of the estate capital taxed).

I would also note that I actually hope my estate tax generates no revenue because individuals choose to donate to charity in lieu of paying a tax to the government as my concept would allow. On the whole, charities can be far more productive users of capital than government bureaucracy. While this would lead to lower revenue, it would alleviate the welfare burden on our government, allowing spending to fall (in all likelihood more than the tax revenue shortfall).

2. Capitalism Requires Meritocracy and Efficient Use of Capital

For a capitalist society to work efficiently, individuals and organizations need to benefit based on merits. The most talented should do better and accumulate wealth because they are superior allocators of capital. It is a good thing Warren Buffett has $75 billion and your Uncle Billy doesn’t because Buffett is more adept at making wise investments and is more likely to pursue projects that generate value. Individuals should rise and fall based in large part on their ability and willingness to work hard.

Large estates are large because someone had a talent and was able to generate value. A just and efficient society is glad and benefits from their accumulation of wealth. However, there is no guarantee their children are equally talented/hard-working. Without an estate tax, those funds can be passed down to a generation that wastes the funds (the Paris Hilton’s of the world if you will). Now, some inheritors do tremendous things with the inheritance, but just as many (more I would argue) do not. In aggregate, society does best when capital is tied with those who are the best allocators of it not those with the best last name.

The American Dream is founded on the idea anyone with enough hard work can rise in society. An aristocracy enjoying the fruits of past generations’ labor can stifle advancement and lead to economic malaise, undermining the advancement of others. That isn’t a capitalist or conservative society. It is a corporatist society benefitting entrenched, status quo players. If we really thought passing down things blindly was so great, why did we ever revolt against monarchial rule? The American experiment is directly juxtaposed to aristocracy, which can arise without an estate tax.

Now, this is not to suggest passing down money is bad. It is wonderful to give one’s children the ability to do anything (problems arise when they have so much they can afford to do nothing). The ability to provide a better life for one’s children, even after one’s passing, can be a key motivator that increases productivity. The danger doesn’t lie in someone passing down $5 million, which can easily be wasted in a generation (or shorter), the danger is in the $5 billion passed down that can let numerous generations ride on the coattails of success. That is why a progressive estate tax is far more rational as it more directly deals with the meritocracy issue without punishing parents for wanting to give their kids and grandkids more opportunity.

Inherited wealth on a large scale can breed laziness and an under-productive over-class in an extreme. For families to rise, some inevitably must fall. An estate tax actually helps to engender meritocracy and thereby enhance growth over time.

3. The wealthy are already disbursing their estates to society

Since launching several years ago, Bill Gates and Warren Buffett’s The Giving Pledge has been a stunning success, getting 138 billionaires to pledge half their wealth (or more) to charity. Again, these participants, under my conception of an estate tax, would essentially face no estate tax liability, since I would fully credit any charitable contributions against the theoretical tax liability. It is telling that so many of the most fortunate choose to give away the vast majority of their wealth. They are beneficiaries of my second point (meritocracy) and understand the importance of preserving that structure, rather than letting future generations fritter away their hard earned wealth. Of course beyond the pledge, countless wealthy individuals are exceptionally generous as well.

Now admittedly, not everyone is a member of the pledge, and some would probably prefer to pass on everything. However, there is some wisdom to the crowd—that is a basic tenet of market economics. For instance, stock prices are fairly efficient and good (probably the best) barometers of fair value because a wide crowd, everyone in capital markets, is buying and selling to the crowd-determined appropriate price. History has proven it hard to beat. Perhaps, the actions of the world’s richest signals the proper policy? While I wouldn’t blindly follow the crowd, it does merit some thought. Moreover, given how much wealth is being donated anyway, the estate tax, if done right, will actually be used in very few instances.

4. It really isn’t double taxation

A common refrain conservatives use against the estate tax is that it is double taxation (taxing already taxed income). That is a bit simplistic, and I would note much of our tax structure, including sales tax, some income taxes, some capital gains taxes etc. are double-taxes. If possible, eliminating all forms of double-taxation would require increased taxation on primary forms of income (unless you are willing to shed hundreds of billion in revenue per year). It isn’t clear that is a preferable system.

Now some estates are as classically argued “double taxed,” but most of the largest estates are not. Most large estates come from entrepreneurs and business founders whose wealth is the equity in their business. This wealth is not taxed prior to death. To illustrate, let’s take the case of Mark Zuckerberg and assume he died Monday before deciding to donate money. He has $45 billion in Facebook stock, but this wealth has never been taxed because it is paper wealth. We tax income (which his Facebook holdings are not) and realized capital gains, and since he is still holding FB shares, the gains are unrealized. When he dies (in the hypothetical), he has actually never been taxed on his wealth. The estate tax would be his first tax not a double tax. Most large estates are similar; much of the estate tax revenue is primary not double taxation.

Plus under current law, the cost-basis of an estate is “stepped-up,” meaning that $45 billion capital gain disappears as his heir marks up the cost-basis to the market price at death. If you eliminate the estate tax without eliminating the step-up feature, his wealth is never once taxed as it passes generation by generation. Meanwhile, workers and W-2 earners (almost all Americans) pay taxes every paycheck. That does not strike me as an efficient structure. Now, we want to incentivize entrepreneurship as they create jobs but no taxation is a bit much. Plus, our current system, in which taxes are deferred until gains are realized, is already an incentive as it lowers the present value of an entrepreneur’s tax bill relative to an employee.

Even if double taxation is inherently bad, which is far from clear and would require a far more drastic overhaul likely resulting in a large consumption tax (which has many negative side-effects), much of the estate tax revenue, particularly from the largest estates, is not a double tax but actually a primary tax. The true picture is a bit more complicated than the political talking points suggest (how unusual!).

5. The confiscation argument against the estate tax doesn’t hold

One constant argument against the estate tax is that it is the confiscation of hard earned wealth, which the government should not be in the business of doing. We could use that rationale for any tax however. The income tax also confiscates the earnings of individuals. Taxation is inherently coercive (optional taxes tend not to generate much revenue), so unless one is willing to argue against all taxes, it is hard to justifiably singling out the estate tax. In any functioning society, there has to be some taxation to pay for public goods. Someone worth $10 billion can still pass down over $3 billion after taxes/charity, which is still a tremendous sum despite my highly progressive proposal. Every tax is by its nature confiscatory and coercive. It is inconsistent to use this argument, often put forth by conservatives sadly, to oppose an estate tax while supporting other taxes.

 

Recognizing this can be an emotional issue for some, hopefully, these arguments at least give pause for further reflection. People of good will and of different political persuasions can disagree on this issue as I don’t see the estate tax as a clear conservative/liberal issue despite how our political parties use it. Ultimately, conservatism is best served when we push for comprehensive tax reform that, yes, includes a reformed estate tax. A conservative-oriented, merit-based society that has an efficient tax code actually necessitates an estate tax, and the two most frequent criticisms of the taxes are a bit lacking.

Death to the death tax is neither conservative nor wise policy.