Negative Impact of Estate Tax

In economics, inheritance means transfer of unconsumed assets from one generation to the next. The goal of estate tax is to reduce the volume of such transfer. Adam Smith in his work, The Wealth of Nations, commented that all taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labor.

Estate tax is nothing but another tax on savings and investments which are already under heavy taxation – income is taxed when it is earned, interest derived from investments and savings is taxed, appreciated value of an asset is taxed (capital gains tax).

A study by well-known economists Henry Aaron and Alicia Munnell concluded that estate taxes are unfair, raise little revenue, impose excess burdens, and have failed to achieve their intended purposes.

Estate taxes reduce the amount of capital available in the economy and thereby reduce the wealth ultimately available to the society. It encourages consumption and discourages savings. It reduces the after-tax return on investment. This causes the capital stock growth to decrease. Capital is vital to economic growth. Estate taxes impede the accumulation of capital. This has a negative impact on economic growth.

Estate tax liquidates and transfers to government control privately held assets which could otherwise be used for maximizing economic efficiency. Instead they are transferred to consumption-intensive government uses.

Estate taxes discourage entrepreneurial activity, hinders entry into self-employment, and breaks up family-owned businesses – a critical component of the U.S. economy. For people of lower income households to move to higher income groups, entrepreneurship is the key. Estate tax prevents upward income mobility by disrupting the transmission of a family business to succeeding generations.

Studies have shown that the estate tax continues to be a primary reason why small businesses fail to survive beyond one generation. Many heirs have cited the need to raise funds to pay estate taxes as the reason why their family business failed. Planning for estate taxes reduces the resources available for investment and employment. Business owners tend to keep liquid assets available to pay off future estate taxes. Estate tax imposes large cash demands on family businesses that generally have limited access to liquid assets.

In a tax system that is fair, individuals with fewer resources pay less taxes than those with greater resources, and all taxpayers with the same amount of resources pay the same tax. However, the rich can afford to use various estate planning options to reduce or avoid estate taxes, and the poor who cannot afford estate planning end up paying more. There are many tax avoidance options available to the general public. To avoid estate taxes, capital owners shift resources from their most productive uses into less efficient but more tax-friendly uses.

Estate tax is extremely primitive and can result in inefficient allocation of resources. The maximum rate for estate tax is presently 45%. It discourages savings and investments and lowers the after-tax return on investments. Estate tax violates the basic principles of an efficient tax system.

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