Is the Estate Tax a Double-Tax?

New York University Professor Lily Batchelder published a paper this week titled “The Silver Spoon Tax.” The paper argues for the United States to strengthen wealth transfer taxes, including the federal estate tax.

The Argument

Her hope is that the next President will increase the estate tax rate, broaden the applicable tax base, and eliminate the stepped-up basis at death. In making her case, Batchelder argues against common concerns about wealth taxes, including the argument that an estate tax is a form of double taxation.

She offers an example of a wealthy individual paying an assistant’s wages from after-tax funds. We don’t view the assistant as already having paid tax on those wages because the wealthy individual and assistant are two separate people. The income and payroll taxes, as her argument goes, effectively tax unearned income from inheritances at a zero rate.

The Rebuttal

A counter argument would point out that simply because two individuals are involved in a transaction should not necessarily make it a taxable event. There is a distinction that the tax code makes (which Batchelder’s argument ignores) between transactions in our economy: an exchange of money for a good or service which generates income, and a money transfer between two people that does not.

The income tax, in general, attempts to tax new income once as it’s created. Imagine if a business produces a good and a consumer buys it with after-tax income. The business pays a tax generated from the sale, but it isn’t considered a double tax on the consumer’s income just because the consumer paid income tax when they earned it. The tax is levied due to the new income attributable to the business from the good or service produced and sold.

On the other hand, a transaction in which no good or service is produced is in a separate category. There are lots of transactions within an economy in which no new good or service is created. One example is alimony, where under the current law, the receipt of an alimony payment is considered taxable. But since this transfer of money creates no new income, to avoid double taxation, the payer of the alimony is allowed to deduct it from their taxable income. The tax code makes a similar distinction (allowing a deduction for payments, but taxing new income) for some other transfers: payroll expenses, business interest expenses, home mortgage interest, and costs of goods sold are some examples.

The example transaction Batchelder uses – the wealthy individual paying an assistant in after-tax income – is one that results in new income. The transfer of wealth involved in an estate tax is more like an alimony payment, which is taxed upon receipt but paid in pre-tax income. With this comparison, it is easier to see why a wealth transfer tax is indeed double taxation.
Some would argue that there are more effective ways to raise revenue from high-income taxpayers. A 2% increase in the tax rate for the top marginal ordinary income bracket replace the estate tax and reduce the overall tax compliance burden.

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