Taxation Law I
Should there be an Estate Tax?
Submitted By: Arvind Srinivas 1555, IV Year, Year, NLSIU, Bangalore
Date of Submission: 12 th August 2011
Introduction
An estate tax is a tax levied on a person who inherits money or property, or a tax on the estate of a person who has died. The concept of an estate tax, categorised under the heading of death duties, were prevalent in ancient Egypt and Greece. 1 The United States has had a an interesting history of estate taxation. The tax in the U.S. Has been levied with the exception of 2010. Similarly the United Kingdom has been imposing an estate tax on the transfer of wealth from the deceased to his heirs since the 19th century.2 Various other countries, including Japan, South Korea, France, Austria and Spain have some form of an estate tax. In India the tax was introduced by the Estate Taxes Act, 1953 but was repealed by the Estate Taxes( Amendment Act) of 1985 citing reasons of low revenue generation from the tax and double taxation due to the stamp duty that was also levied. This research paper looks into whether there is a need for an estate tax or not 3.
This research paper proceeds on the hypotheses that the very basis of estate tax is impractical and hence the tax itself is ineffective and unnecessary. The research questions that have to be answered to prove the hypotheses are as follows: •
What is the justification for estate tax?
•
What are the arguments for and against estate tax?
•
Do the disadvantages of estate tax outweigh its advantages?
The research paper is structured in such a manner so as to examine the arguments both for and against the levying of an estate tax and then critically analysing the arguments to determine the outcome of the debate.
1
2
3
D. Frederick, “Historical Lessons from the Life and Death of the Federal Estate Tax”, 49, American Journal of Legal History 197 (2007). D. Holtz-Eakin, “The Uneasy Empirical Case for Abolishing the Estate Tax’, Vol 51 Tax Law Review 495 (1995-96). Budget Speech of Mr. V.P Singh, for the year 1985-86 available at www.indiabudgets.nic.in accessed on 11/8/2011.
Arguments for Estate Tax
The arguments in favour of an estate tax, in brief, are as follows: •
Estate tax plays an important role in ensuring the creation of a fair and equitable society
•
The progressive nature of the estate tax is needed as tax regimes are becoming more and more regressive
•
Estate tax is an important means of revenue generation for the State
•
Charitable institutions benefit from the exemptions provided while imposing an
estate tax
Estate Tax and an equitable society The principal argument for imposing an estate duty arises from its potential to facilitate the creation equality of opportunity. By decreasing the amount of wealth that is passed on from one generation to the next, the estate tax creates a situation in which the privileged start off on a relatively equal footing with the underprivileged 4. There are two effects brought about by the decrease in transferred wealth. Firstly it reduces the chances of wealth accumulation in the hands of the elite few. In an extreme scenario, the estate tax is a disincentive for the transfer itself as the value of the inheritance is not enough to justify the tax payable. In a more moderate sense estate tax acts as a tool for moderating the amounts of wealth that can be accumulated, as typically, large fortunes are the product of wealth accumulation across generations. Secondly, the wealth tax ensures that the subsequent generation has to work hard to develop the wealth that has been passed on to them. For example if the subsequent generations did not work, ultimately the estate tax across generations would amount to a signifiant loss to the amount of wealth being passed on. 5
Progressive Nature if Estate Tax Estate tax has been hailed as one of the most effective means of imposing a regime of progressive taxation.6 A progressive tax system is a tax system that collects taxes based on 4
5 6
R. Momburn, “Lets Protect our Economy and Democracy: The Case for Keeping the Estate Tax”, Vol. 84 Taxes 29 (2006). Id M.C.Mirow & B.A. McGovern, “An Obituary of the Federal Estate Tax’, Vol 42, Arizona Law Review 625 (2001).
‘the ability to pay’ model rather than on the benefits model and is generally considered to be one of the features required for a good taxation system. The virtues of a progressive system of taxation basically derive from the principle that the income of a person is not only because of his efforts and is also related to several other factors. It is also based on the notion that most of the benefits provided by the government such as defence and maintenance of law and order are of more value to rich people than their poorer counterparts. 7 An estate tax with a higher marginal rate on larger estates is an excellent contributor to the progressive nature of the tax system. As consumption based taxes are becoming more and more common, the value of the estate tax in its role as a progressive tax has increased drastically.
Estate Tax as a means of Revenue Generation Estate Tax was an important means of generation of revenue in the past. However now it is merely a minor contributor.8 In the United States, estate tax reaches its peak between World War I and World War II9, where it contributed 11% of the revenue generated. It has remained stagnant at around 2.5% since then. Similarly in the UK the contribution of estate tax has decreased from 21% to 2% in the recent past. 10 The maximum revenue generated from estate tax in India during the financial year 1984-85 was Rs 20 crores.
Gain to Charitable Institutions A minor argument made by those in support of an estate tax is that an estate tax which allows for exemptions is beneficial to charitable institutions and causes, because of the higher marginal rates at the top end of the band and as contributions are made to the same in order to avail the exemptions provided by the estate tax. 11
7 8 9
10 11
M.J. Graetz , “To Praise the Estate Tax, not to Bury it’, Vol. 93(2), Yale Law Journal 259( 1983). Id L.E. Burman & W.G. Gale, “The Estate Tax is Down but not Out”, Tax Policy Issues and Options No. 2 (December 2001). T.R. Ireland, “Inheritance Justified: A Comment”, Vol. 16(2), Journal of Law and Economics 422 (1973). J.M. Bakija & W.G. Gale, “Effect of Estate Tax Reform on Charitable Giving”, Tax Policy Issues and Options No. 6 (July 2003).
Arguments against Estate Tax
The arguments against the imposition of an estate tax, in brief, are as follows: •
Estate tax gives rise to a possibility of double taxation
•
Estate Tax acts as a disincentive to savings
•
The tests of fairness, neutrality and efficiency are not satisfied by an estate tax
•
The costs are greater than revenue generation in the case of an estate tax
•
There are also emotional arguments against estate tax
Possibility of Double Taxation The most important criticism against estate tax in India, which was one of the factors in the abolition of the tax in 1985 was that stamp duty was already levied on property which was transferred from a person to his heir. 12 This gave rise to a scenario of double taxation as the same transfer is being taxed twice.
Estate Tax as a disincentive to savings Estate taxes also face criticism on the basis that they encourage consumption of wealth by high income individuals resulting in an adverse impact on savings and retention of capital assets.13 As the growth of any economy depends on savings, estate tax has a negative effect on the growth of the economy. In addition to this estate tax is a progressive tax on a capital receipt, thus invoking more criticism.14
Fairness, neutrality and efficiency One of the biggest arguments against estate taxes is on the grounds that they do not meet the requirements of fairness, neutrality and efficiency.15 The fairness of a tax may only be measured once it is levied. An estate tax law which is similar to most existing laws will fail
12 13
14 15
Supra note 3 W.G.Gale & J.B. Slemrod, “Death Watch for the Estate Tax”, Vol 34, Journal of Economic Perspectives 435 ( Feb. 2001). Supra note 4. K.M.Schlachter, “Repeal of the Federal Estate and Gift Tax: How it will Happen and how it will Affect our Progressive Tax System’, Vol 19, Virginia Tax Review 781 (1999-2000).
the fairness test as it fails the test of both vertical and horizontal equality. 16 The tax is not being neutral as it drives tax payers to alter their pattern of behavior so as to reduce incidence of the tax.17 The tax has also been criticized as being inefficient as costs exceed the revenue generated.
Costs v. Revenue generation As seen earlier estate tax has been reduced to being a minor percentage of the total revenue generated. It is also argued that it costs more in economic terms due to various distortions than the revenue it generates.18 This theory is based on the meagre amount of revenue generated by estate taxes as well as taking into consideration the economic costs of the distortions that are brought about by people who adapt their behavior in order to minimize estate taxes payable.19 In addition to these factors, it is also important that the administrative costs, involved in computation and collection, be taken into account.
Emotional arguments An emotional argument, albeit one on shaky grounds, is that an estate tax is that it is the levying of a tax on the death of a person. The State is criticised for taking away the assests of the heirs rater than consoling them. 20
16
17
18 19 20
P.L. Caron & J.R. Repetti, “The Estate Tax Non-Gap: Why Repeal a Voluntary Tax ’, part of the University of Cinicinatti- College of Law Public Law and Research paper Series (2002). R. Momburn, “Lets Protect our Economy and Democracy from Paris Hilton: The Case for Keeping the Estate Tax”, Vol. 33 Ohio Northern University Law Review 61 (2007). Supra note 10 Supra note 10 Supra note 4.
Concluding Remarks
The basis of levying an estate tax is that it helps in creating a fair and equitable society. This is supposed to happen through the reduction in the transfer of wealth across generations, bringing about equality of opportunity, and by the tax acting as a disincentive for wealth accumulation in the hands of the elite few. The basis for the tax, while admirable in its intent, is highly impractical. An example would facilitate the impracticality of the tax. In a situation wherein a billionaire transfers his estate to his heir and the heir pays the estate tax, will the tax really significantly reduce the amount of wealth that the heir has inherited? With the resources available to him the heir can recoup the tax payed in no time at all. In the second situation, a middle class man passes on his only house to his heir, who then has to pay the estate tax. In such a scenario the reduction in wealth is relatively more significant than in the first scenario. Thus the researcher argues that the tax in fact has the effect opposite to its original purpose. In no way, is there equality of opportunity, or any significant progress towards the same, created by the tax.
As far as the tax being a disincentive toward wealth accumulation, once again it can be said that such a claim is naive. No reasonable person will refuse an inheritance just because he or she has to pay a tax on the said inheritance. The only possible situation in which the tax can be a deterrent is if it is large enough for the benefits of the estate to be overshadowed. In such a case the tax is neither fair nor equitable and is again at cross purposes with its original intent.
The reasoning behind the repeal of the tax in India in 1985 was that as stamp duty is already levied on the transaction, the imposition of estate tax would lead to taxing the same transaction twice. The possibility of double taxation does not stop here. Being a progressive tax, estate tax is based on the ability to pay, rather than actual accrual or receipt. In effect the estate tax becomes a tax on the notional value or the expected gain from the estate that is passed on. However these are already taxed especially in the cases of the estate being in the form of house property. Though the estate tax is a one time tax, it is still levied on the same basis as the tax on house property resulting in double taxation. Inadvertently, the estate tax
has overstepped its original justification and the ancillary purpose thus obtained stands as an argument against its imposition.
As a means of generation of revenue, estate tax has long been insubstantial. The costs that are attached to the tax in the form of administrative costs and in the form of adaption in behavior of the tax payers to avoid the tax are far greater than the revenue generated. Finally an emotional argument can be made on an emotional basis that the State is being insensitive by taxing the death of a person.
There are far better methods of achieving the objective that was originally sought to be met by the levying of an estate tax. Some of them are tax related and some are steps integrated in non tax statutes. Specifically levying a stamp duty is much more effective and ensures administrative ease. Generally there are a host of other taxes that aim to reduce the gap between the rich and the poor. As far as wealth accumulation is concerned, a provision such as the rule against perpetuity in s.14 of the Transfer of Property Act is far more effective than an estate tax.
In conclusion the researcher states that the disadvantages of an estate tax far outweigh its advantages and that there are better ways of achieving the object of achieving an equitable society.
