David Stewart 0:01

Welcome to the podcast. I'm David Stewart , editor in chief of Tax Notes Today International. This week: death taxes. The estate tax, the inheritance tax, the death tax — whatever you call it, it's controversial, but very few people pay it. Here to talk about what it is and perceptions of it is the director of the Tax History Project and Tax Notes contributing editor Joseph Thorndike. Joe, welcome to the podcast.

Joe Thorndike 0:34

Hey. It's great to be here.

David Stewart 0:35

All right. Let's start off with terminology. I mentioned that there are many different names around the same concept. Has it always been called the death tax? And is that just kind of a loaded phrase?

Joe Thorndike 0:44

Well, you know, oddly, it has always been called the death tax, at least by some people. Nowadays, we think of that as a politicized term because it was sort of rediscovered or reinvented in the 1990s by opponents of the estate tax. But long before that, people used to call all sorts of taxes death taxes. They would call the federal estate tax a death tax. They called state inheritance taxes a death tax. They would call, well any kind of a transfer tax that is occasioned by death seemed reasonable to call it a death tax. So it's interesting that we now see this as a way to attack the tax, but it used to be just considered, you know, descriptive, because again, it is tied to the event of death.

David Stewart 1:22

And now is there a difference between an inheritance tax and an estate tax?

Joe Thorndike 1:25

Well, so an estate tax is levied on the big bulk of an estate that a dead person leaves behind before it's distributed to all the beneficiaries of that estate. An inheritance tax, by contrast, and these are used by the states principally, is levied on that distributive share of the larger estate that goes to an individual person.

David Stewart 1:42

Now, I have to admit, I've heard the term before, but never been entirely sure of what it is. What is a generation-skipping transfer tax?

Joe Thorndike 1:49

Well, it's just a way to make sure that people don't avoid the estate tax by handing off money to generations, not just their children, but say their grandchildren or their great grandchildren. And it's a way to shelter a big chunk of money from taxation for a long time. So they don't want that. So they actually impose a tax, which looks a lot like the regular estate tax, on any kind of bequest that goes to a generation beyond just your children.

David Stewart 2:11

All right. Well, let's talk a little bit more about what really it is. Is this a tax that is a tax on the death or is it a tax on something else? What really are we getting at taxing when we do an estate tax, inheritance tax, whatever?

Joe Thorndike 2:24

You don't exactly get in trouble for dying, right? You're not actually taxing the fact that you died. But it is occasioned by the fact that you die and you then want to transfer some assets to the people you leave behind. So, tax people like to call it a transfer tax because it's taxing that right to make a transfer. Now, this, I think, starts to quickly get into the politics because a lot of people think that the right to transfer assets to your children, for instance, is not something that government has and then chooses to give you. But it's just sort of like part of the world —it's my right as a human being, but that's leading into the political issues around it. But it is a tax on the right to transfer wealth after death.

David Stewart 3:00

Now how does it work in the U.S. system? There's been a lot of changes over the last several years. How does it function these days?

Joe Thorndike 3:06

All right. Basically, it applies to the transfer of any sort of assets like cash or real estate or stock, but only on really big estates. So these days the exemption is $11.2 million for a single person. So for couples, that means that you can transfer $ 22.4 million to your heirs and not owe any estate tax on it. So this actually means that very few people actually end up paying the tax. The top 10 percent of income earners, I'm just using income earners as sort of a proxy for rich people, pay more than 90 percent of the estate tax and almost 40 percent is paid by just the richest 0.1 percent of income earners. So there really aren't many family farms in this grouping. There's not a lot of small businesses. I think there are about 4,000 estate tax returns in our most recent numbers for people who died in 2018. Only about 1,900 are taxable. That's less than 0.1 percent of the 2.8 million people expected to die that year. So another way to think about this is 99.94 percent of estates are exempt.

David Stewart 4:05

How much money are we talking about raising here?

Joe Thorndike 4:07

You know, it's not nothing, but it's not a big ticket item anymore, partly because we've raised the exemption so high. But it raised about $15 billion in 2018. That's less than 1 percent of total federal revenue, so this is not going to pay for a whole lot. It's not going to break the bank if we don't have it. The point of it at this point, although historically this is not true, it is not really a revenue argument so much at this time as it is a fairness argument.

David Stewart 4:30

Right. You mentioned that this isn't really catching the family farm. Who does it really catch?

Joe Thorndike 4:34

I mean, it really catches just really rich people. And then the question becomes whether it even catches them very well because there are avoidance techniques for the estate tax. It used to be said that it was an optional tax because anyone who did enough tax planning or had enough tax planning done for them could avoid it. But I mean, at $11 million, $22 million, you know, for a couple leaving stuff behind, you're really only taxing people who are really quite wealthy. I mean, there can be large farms and that sorts of things. I don't mean to draw too clear a line here, but 40 percent is paid by this top 0.1 percent, so that's a tiny fraction. I don't want to say it's a tax on plutocrats, but it's a tax on the extremely rich, not just the very rich.

David Stewart 5:12

All right . Let's turn really into your wheelhouse here into the history of this tax . Now how long have these taxes that could be called death taxes been around?

Joe Thorndike 5:19

Honestly, people have been trying to tax death or tax events around death for about as long as they've been taxing anything. You can find them in death-related texts in ancient Egypt and ancient Rome. European history is filled with them. As soon as there are taxes being collected by modern states, they're pretty much collecting some kind of death-related tax. But let's bring it a little closer to home, to the U.S. The U.S. starts really early with a version of the estate tax. They have one in 1797 to help fund what they called the Quasi-War with France. We never actually got in a war with France, but we were sort of shooting each other's ships and they needed to find a way to pay for that. It disappears and then it comes back during the Civil War to help pay for that war. That comes about in 1862, it lasts until 1872, and then it goes away again because people don't like it. It comes back in 1898 because they need to fund another war. So with the storyline here, and at least in these early years, is that it's a war tax. Now most taxes are war taxes in the early period of American history. Most of them are levied and then repealed later on. And it's fair to look at the estate taxes that, as an emergency tax. But that all changes in 1916 when Congress for the first time levies an estate tax that it plans on keeping around for a long time.

David Stewart 6:27

So this sort of coincides with the income tax coming in permanently?

Joe Thorndike 6:31

Yes. And so there's basically a broader revolution going on at the time and the way people think about tax. Until then they're raising all the federal revenue pretty much with with tariff duties, which are newly popular again, but then we're really raising most federal revenue. And they were also had a couple of excise taxes on things like alcohol, tobacco, but people thought rightly, this is really regressive. These sorts of taxes fall really heavily on poor people, so what we need are some taxes to fall on rich people. And so from the beginning, talk about creating a new federal income tax generally included talk about creating a new estate tax. So in 1894 they enact an income tax and no estate tax because they decided to treat estates as regular income. Any inherited property is treated just like regular income. That income tax doesn't go anywhere. But in 1913 we famously get this federal income tax for the first time that sticks around in the — well not the first time, it's the second time because there's one in the Civil War — but it comes back in 1913. And then soon after that they create an estate tax in 1916. The question really is what were they trying to accomplish? Right? Then, like now, there's a lot of talk about inequality and growing inequality and how this was unfair and dangerous and threatened the body politic and all of that. And so there's one question is were they planning on using the estate tax to get rid of some of this inequality? To redistribute this wealth that was going to a few super rich people and give it to everybody else? And the short answer to that is not really. There were definitely some people who are interested in that, but for the most part, they were interested in not redistributing wealth, but in redistributing the tax burden. So it goes back to that tariff thing, right? These tariffs are too regressive. We need to find some way to balance it out, to balance the overall burden of the federal revenue system. So let's add to these regressive tariffs, which we're going to keep around, some new progressive taxes. One is the income tax and one is the estate tax. And I don't want to minimize this because there is some interest in redistributing wealth, but primarily it's about redistributing the tax burden. And there's a quote here from this guy, Rep. Cordell Hull, who's known as the father of the income tax, but also the estate tax. He says, "I have no disposition to tax wealth unnecessarily or unjustly, but I do believe that the wealth of the country should bear its just share of the burden of taxation and it should not be permitted to shirk that duty." That's really what the estate tax is trying to do back then.

David Stewart 8:45

OK. Well, let's fast forward then into more recent history. And there seems to have been a lot of moves against having an estate tax. So what's been happening in more recent times?

Joe Thorndike 8:55

Well, so it's actually easy to tell the middle part of this story because it's not very exciting. They create the estate tax. It's actually relatively uncontroversial as soon as they create it. There's a move during the New Deal era when Franklin Roosevelt says, "Great accumulations of wealth can't be justified on the basis of personal and family security." But nothing happens. They don't really change the estate tax system and instead it sort of just chugs along. And it doesn't attract lots of hostility from conservatives, but one thing it also doesn't happen is that they don't really modernize it very well. So in particular, the exemption that they create, which is the size of the estate, a portion of the estate , which is exempt from tax, no matter what, doesn't change from 1942 to 1976. It stays at $60,000. Well, a lot of things changed between 1942 and 1976, including the value of $60,000. And so by sort of not paying enough attention to the estate tax, not modernizing it, not keeping up with the changes in the economy, the estate tax got a little out of whack. You know, when it was first created, the exemptions were designed to really hit only very rich people. But as the exemption remained in place and inflation continued, it started to erode the value of that. And suddenly the estate taxes taxing really rich people, but it's starting to maybe reach into the upper middle class, too. And particularly people who buy houses that appreciate quickly. By the 1990s, this sense that it's not just burdening the plutocrats anymore, it's a problem for the middle class. And so in the 1990s, you see a growing movement. It really starts in the '70s but it picks up speed in the '80s and then into the '90s to get rid of this tax or at least to sort of gut it.

David Stewart 10:29

And then turning to this century, there was a brief period, remember, where it just disappeared entirely for a year?

Joe Thorndike 10:35

Yeah. So in 2001, the great accomplishment of this anti-death tax movement that grows up, they do actually repeal the estate tax in 2001, but they put it off for a bunch of years. And they say , "Well, we're going to gradually get rid of it and then it'll be gone." It was saved from death at the last minute when they had to do this with a lot of the so-called Bush tax cuts that were enacted during the George W. Bush presidency. The estate tax was saved from this disappearance, although it did disappear for one year and then they sort of reached back and recreated it. The idea was, again, I think that the estate tax was unpopular. It has polled really quite badly and we can talk about that more in a minute. It even not popular then, but it was seen as part of this larger progressive thrust of the tax system to get rid of the estate taxes to hand a benefit to very rich people. And there was a sense that that was a bad idea. So yeah, saved from death as it happens. The death tax.

David Stewart 11:25

All right . You alluded to this, why is the estate tax so unpopular?

Joe Thorndike 11:29

Right? Because why should it be unpopular? Almost nobody pays it . If your view of tax is that, "Don't tax you. Don't tax me. Tax that guy behind the tree." Right? T hat the only thing people care about is that they don't get t axed themselves. It doesn't really make any sense c ause this tax polls very badly and yet no one actually pays it. So there are a lot of ways you can try to explain that and you can say that maybe people are confused and maybe they are, but there's interesting research that goes on around this. There's a guy Steve Sheffrin who wrote a great book called "Tax Fairness and Folk Justice," which tries to tease out what is it about the estate tax that makes it so unpopular even though no one pays it. And there is, I think this idea that tax is tied to a couple of things like death, which is a sort of freighted issue for anyone, right? It just awakens fears and anxieties or whatever, but also it's tied very closely to the idea of family obligation. What it really seems when you start interviewing people and talk to them carefully about what they don't like, that a lot of what people don't like is this idea that the estate tax gets in the way of providing for your children. And that families have a right to pass on wealth and security from one generation to the next. T he estate tax seems to threaten that. So I don't think anyone has the definitive answer on why the estate tax is unpopular. Some people think everyone worries that they're g oing t o pay it someday, but that doesn't seem plausible to me. It seems much more likely that the tax itself, because it's structured around the death of an individual and then what is done with the assets as they pass to the next generation, that that offends the sensibilities of a lot of voters who feel that the right to pass wealth to your children is sort of a God-given right shouldn't be regulated by the government. There's a lot of ifs and maybes and w hatnots in there, but it does seem to me that that gets us closer to figuring out why this very unpopular tax is so unpopular when it shouldn't be. By comparison, a wealth tax polls very well. So this is t he question that we're g oing t o have to wrestle with it looks like in the next year during the presidential election. When proposals are out there for a wealth t ax, why is it that that tax does so well o n the estate tax does so poorly? I think there are reasons for both sides to be concerned about those odd facts. Supporters o f a wealth tax shouldn't be so quick to assume that t heir tax will stay popular because the estate tax looks a lot like a wealth tax. But it's also true that they may be o n t o something, these supporters of a wealth t ax, that the tax might be different enough from the estate tax that i t will remain popular. So I think this is sort of the modern salience of this issue that we're trying to sort out.

David Stewart 13:48

You say that an estate tax is sort of like a wealth tax. Could you go deeper into that? How does it function like wealth tax ?

Joe Thorndike 13:53

Well in just in so much as it's more in sort of intentionality. They are both driven by a concern about inequality. They're both driven by a concern about the fairness and allocation of the tax burden, of the revenue-raising burden of the federal government generally. And both of them go after big accumulations of wealth and try to do something with them. Now, a wealth tax taxes a big chunk of wealth every year at a very small rate that tends to raise a lot of money over time. The estate tax meanwhile walks in and takes 40 percent of everything above the exemption all at once. That may also be one of the problems with the estate tax is that the rates tend to be very high above the exemption. Both of them are targeting the same sorts of people basically, and they're both targeting rich people. And to take the people out of that, they're targeting accumulations of wealth. And there are many people I think who are concerned about accumulations of wealth. And this is actually what Franklin Roosevelt was very articulate about saying, was that he felt that large accumulations of wealth were a danger to democracy because they gave too much power to too small a group of people. Well, wealth taxes are meant to do something about that, so are estate taxes. They function very differently. One happens once. Wealth taxes happen all the time, every year, but they are both driven by the same impulses.

David Stewart 15:10

Now let's say a policymaker is being driven by those same impulses and wants to find a way of taxing wealth other than an estate tax or a wealth tax. Are there other options?

Joe Thorndike 15:19

Yeah. And maybe less politically complicated options. You know, there are people out there, tax professionals these days who say wealth taxes is an interesting idea. It's probably unconstitutional for reasons we don't need to get into right now. The estate tax does not have that problem. But there are easier ways probably to go after these accumulations of wealth than a new wealth tax or even a very unpopular estate tax, although some of them would work in conjunction with the estate tax. So for instance, you can raise marginal rates on income. That does something. It doesn't directly resolve this problem of large accumulations of wealth and take them apart, but it does it in sort of piecemeal fashion. So that's one thing you can do. You can also tax capital gains like regular income. Right now, capital gains get taxed at a preferential rate. That has almost always been the case in American tax policy, although not for a few years during the Reagan presidency, strangely. But if you were to decide, well, let's tax capital gains just like regular income, that would hit a lot of the same people. People who own lots of stock alone, lots of assets that appreciate over time. And then the last part of that, and this would sort of work in conjunction with the estate tax, is that when a person dies now and hands over, let's say a house, to their child, the child's basis in that house, so for tax purposes that's half the calculation when you're trying to figure out what kind of tax you owe , you're going to get a stepped-up basis nowadays, which means the value of that house for tax purposes is going to be what it was when you received it. What you could say is the increase in the value of that house has never been taxed because let's say the person bought it for $100,000. It's $1 million when they're going to give it to you. $900,000 has never been taxed because the house has never been sold. Well, you could say somebody is going to have to pay that tax at some point and you'd give it to the person, you give it to them with that $100,000 price tag. And then when they sell the house, they are going to pay tax on the whole thing. So this is a somewhat complicated topic for non-tax people. It's certainly hard to put together a soundbite around stepped-up basis and why it allows people to avoid taxes. But you could do a lot to reduce these large accumulations of wealth by simply saying you're not going to get a stepped-up basis. You're going to have to use the basis that this person originally had in this asset, the person who's now dead. And I think that strikes me is something that might actually happen partly because people don't understand it all that well. Right? The estate tax is controversial because people see death and family and that's something that can kind of get their head around and they might not like it. But a stepped-up basis might just be wonky enough that it won't actually catch the kind of political flack and so that is another way. In some ways, maybe one of the most plausible ways that you could tax wealth without a big political blowback.

David Stewart 17:51

Well, Joe. This has been fascinating. Thank you for being here.

Joe Thorndike 17:53

It's my pleasure. Always enjoy it.

Coming Attractions with Faye McCray

David Stewart 18:01

And now, coming attractions. Each week we preview commentary that'll be appearing in the Tax Notes magazines. I'm joined by Content and Acquisitions Manager Faye McCray. Faye, what will you have for us?

Faye McCray 18:10

Thank you, Dave. In Tax Notes Federal, Abraham Sutherland argues that cryptocurrency reward tokens should be included in gross income when they are sold or exchanged. Hank Adler and Madison Spach explain that a national wealth tax would impose direct taxes without apportionment to the states and would therefore violate the Constitution. In Tax Notes State, Dennis Rimkunas launches his column with the help of Brendan Ballou, by describing how New York courts have historically interpreted tax exclusions and tax exemptions and the admitted flaws in that framework. Timothy Noonan and Emma Savino discuss New York City's unincorporated business tax. In Tax Notes International, Jérôme Monsenego discusses a Swedish Supreme Administrative Court case involving the application of the construction permanent establishment rules in article 5 of the OECD model tax convention. Amy Ling and Jason Wen discuss China's efforts to stimulate economic development by revamping tax policy to focus on rate reductions. And on the Opinions page, Robert Goulder considers the use of human rights arguments in the context of international tax reform and Nana Ama Sarfo looks at the Democratic push to implement public country-by-country reporting in the U.S.

David Stewart 19:30

You can read all that and a lot more in the November 4th editions of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @ TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts .org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.