Support of inheritance tax in NZ and the UK

Two of my favourite applied economists have come out in support of inheritance taxes (to some degree):

In NZ we have David Grimmond of Infometrics:

A means of correcting for dynastic privilege is to introduce a uniform tax on capital. The absence of bequest taxes, in combination with a lack of uniform tax on capital, is a stark aberration in the New Zealand tax system

Then in the UK we have Patrick Nolan of Reform:

In this environment it is unclear why reducing inheritance tax should be a priority. It could be argued that falling property prices mean it would now be relatively cheap, with some estimates indicating that the cost has fallen by almost half to £1.3bn for 2011-12. Yet this is money that could be put to better uses – including reducing other more harmful taxes.

I am a fan of inheritance taxes – as they don’t distort economic behaviour to the same degree as other taxes.  If we want to change the tax system this is the sort of tax we should be introducing – with a corresponding cut to the top tax rate.

  • Gotta be very careful on implementation of this kind of thing. Hamfisted versions result in kids having to sell the inherited family home or business because they can’t afford the taxes.

    Hasn’t there been work showing a fairly big distortionary effect of inheritance taxes? See here for example.

  • @Eric Crampton

    Indeed – it needs to be well implemented. However, I was under the impression that the distortionary impact of inheritance taxes was still lower than the impact of straight income taxes – because the current generation discounts the value of future generations.

    If the current generation valued the future generation at the same level as they do themselves – then an estate tax is effectively a direct tax on savings. This is indeed no good.

    However, if current generations don’t care about future generations sufficiently, then any left over estate is merely a result of people dieing even though they believed their was some positive probability of living in the next period – this estate acts as a windfall to the next generation that is independent of their actions. As a result, it is less distortionary for the government to take some of this money to replace incomes taxes and the such.

    So I guess it all boil down to a value judgment regarding how one generation cares for the next one …

  • Even if the current generation discounts the future one, it’ll invest a lot of resources into estate planning as t -> T. These are deadweight costs that count against an estate tax.

  • @Eric Crampton

    It is definitely true that they discount the future generation – but the question is whether they discount them more heavily than they would discount themselves at that point in time. If they do this heavily, then the estate tax isn’t too bad.

    Also, I am not sure it is fair to assume that there will be a terminal period – part of the reason that bequests are left is because people don’t know when they will die, they just believe there is some probability of dieing. In this case, we are almost always left with bequests because agents will never put a p=1 on death in any period, almost ever.

    Now I do realise that there are bequests because people care about future generations as well – and insofar as this happens, this will act as a tax on income. However, we have to weigh up any distortion from this with the distortions from income tax, and direct taxes on capital investment.

    I agree that, if the next generation is valued in the same way that the current generation would value themselves at that point in time, then a bequest tax + a GST rate would be equivalent to an income tax – in this environment the bequest tax acts as a tax on savings.

    However, in so far as the discount factor differs – and bequests are left because of the ex ante probability of death never being one, even though ex post sometimes people die, there is a case for such a tax.

  • Everyone knows that p=1 in the long term. So, folks start serious estate planning as p starts to get highish relative to estate value.

    You’re right for folks who don’t leave much in terms of bequests. If all bequests are just accidental transfers based on folks getting wrong the precise timing of their deaths, then there’s no real worry. But lots of folks leave intentional bequests. Not many folks go the reverse mortgage route, or sell the house, rent as t –> T and consume as much of the capital stock as possible.

    I’m sure I’ve seen estimates putting the deadweight costs from estate tax planning as being on the very high side of deadweight costs from other forms of taxation….

  • “I’m sure I’ve seen estimates putting the deadweight costs from estate tax planning as being on the very high side of deadweight costs from other forms of taxation”

    Interesting. If that is the case then I’d put an update on my post – my impression was that estimates said the opposite to that.

  • Pingback: Topics about Economy » Archive » Support of inheritance tax in NZ and the UK (463180)()

  • Andrew Coleman

    Well at least this tax wouldn’t mean too many more tax collectors. But think of the extra lawyers that we will need to set up trusts to ensure that estates weren’t taxed. Plus pressure to increase the amount of in vivos transfers. And think of the demand for matchmaking services for elderly widows or widowers. There would be a real incentive to marry someone old so that their estate wouldn’t be taxed (assuming that an estate wouldn’t be taxed if it was left to a surviving spouse).

    One is reminded of the marriage market in US civil war veterans in the 1920s: marry an old veteran, and get a pension for life. The last civil war pensions were paid out in the late 1990s/ early 2000s. But if there were a marriage exemption on an estate, the possibilities would be endless.

    If you want to tax wealth, just crank up GST. Better still, give greater incentives/recognition to people who give money away if that is what they want to do, rather than confiscating it off them.

  • @Andrew Coleman

    Very true – there are substantial issues with trying to form and legislate such a tax. Hence why David mentions a universal tax on capital.

    I agree that a GST ultimately captures all wealth – as the value of wealth is only through its eventual consumption. However, such a tax is again equal to a flat income tax. If that is what we believe in that is fine, but if we assume that there is some sort of progressive, distributional, issues we are interested in we have to move past a higher GST rate.

    Viewed in this light, a tax on capital (or a functioning bequest tax) could be superior (in social welfare terms) to a progressive income tax.

  • Pingback: Inheritance Tax Planning - The Tax Man Cometh - Stop Him NOW | NotWeb Network()