Once upon a time, tax experts used the term "death tax" to refer to the federal estate tax without opprobrium. Back in the day, the term was not freighted with political baggage. Rather, it served as a sort of shorthand for any sort of levy imposed on estates or inheritances.
Excerpted below is one example of this usage, drawn from a major tax policy study conducted during the New Deal. The authors, Carl Shoup and Roy Blough, were both strong supporters of the estate tax.
TO UNDERSECRETARY OF THE TREASURY
ROSWELL MAGILL (September 20, 1937)
DEATH AND GIFT TAXES
1. THE DESIRABILITY OF DEATH TAXES
UNIVERSAL ACCEPTANCE: Taxation of the transfer of property at death has been one of the most universally used tax forms in history. The purposes have included both revenue and control. The institution of inheritance is recognized to be specially granted privilege allowed only because the results therefrom are believed to be socially desirable; principally perhaps because of the encouragement given to the production and accumulation of wealth. When the danger of the concentration of wealth in the hands of a few persons has been thought to outweigh the desirability of wealth accumulation, inheritance has been limited and modified, largely through taxation.
PAINLESSNESS: Death taxes constitute a relatively painless method of raising revenue. The descendent is dead so the tax cannot hurt him at the time it is imposed, although of course it may have caused sacrifices during his life that he would not otherwise have borne. Perhaps usually the legatee or beneficiary has not sacrificed to create the wealth so the tax causes him no real sacrifice, although of course a wife or son may have helped build up the estate. An inheritance is probably looked upon by most beneficiaries as an addition to capital rather than as expendable income, so that the tax has relatively little effect on the beneficiary's standard of living. The beneficiary usually has other financial sources than the inheritance although in the case of widows and minor children this statement would perhaps not be true. If the tax is anticipated, no expectations are frustrated. All taxes cause some sacrifice, but the inheritance tax causes less than others.
ECONOMIC EFFECTS: Since death is an uncertain future event and since it removes from the scene of action the person chiefly interested, death taxation probably has less effect on the individual's activities than do other more immediately pressing taxes. A strongly urged argument is that heavy death taxes discourage the decedent from working and accumulating and thus prevent the creation of economic wealth that would otherwise be created. Against this view it is urged that because the tax will take a large part of the estate, the individual is encouraged to work harder and save more than he otherwise would in order to leave a competence to his heirs. Probably the forces of the two motives differ among individuals. However, the motives that induce most work and accumulation are likely to be found in an individual's own life rather than in his interest in his heirs, especially when the fortune becomes more than adequate to support his near kin.
The effect of the inheritance tax on the inheritor of wealth is probably to encourage work and accumulation. Much of the best mental power of the nation is wasted because its possessors do not need to work. While heavy inheritance taxes might deny some capable persons of capital needed to exercise their talents (although most inheritances appear not to be received until middle age), on the whole heavy inheritance taxes by making work necessary would probably lead to greater production and accumulation by the beneficiary than if such taxes were not imposed.
Perhaps the most influential argument brought against death taxation is that it destroys accumulated social capital. The argument runs that in order to pay the tax the estate must be liquidated, wholly or partially.
This liquidation is accepted as a destruction of social capital. This, however, is a fallacious view. Social capital consists of tangible wealth, which cannot be destroyed by merely selling the estate. The estate is sold to someone who buys it out of his income or out of his liquid accumulated savings; the social capital continues to exist.
A more valid contention is that death taxation slows up the formation of social capital. The purchaser of the assets of an estate buys them as an investment. He does not distinguish between such an investment and an investment in the production of new capital. Accordingly less liquid funds are available for investment in new capital than would probably be the case if inheritance taxes were not imposed.
Effects on social capital are in no way peculiar to death taxes. Highly progressive income tax rates, which also reduce the volume of funds available for investment, have a similar result. Indeed, the effects of income taxes on enterprise and accumulation are probably greater than those of death taxes. Income taxes apply to the present, the estate taxes to an uncertain and often distant future. Income taxes affect directly the rewards for enterprise; those rewards may never, and most of them probably will never be, subject to the estate tax.
The seriousness of this discouraging effect on capital growth depends on the ease with which a society may accumulate capital. In the early days of the capitalistic system the great need of new capital and the difficulty of accumulating it may have made heavy death taxes undesirable. At the present time, however, the surplus of the productive power of the country over minimum necessary consumption is so great that needed new capital can be brought into existence with little sacrifice and almost at will through the use of bank credit. Accordingly the argument against death taxes on the grounds that social capital is thereby prevented from growing is probably not a particularly significant one today. More light on this point, however, is badly needed.
Death taxes so severe as to result in a very substantial redistribution of wealth might result in the gradual decrease in the volume of social capital. The demands of the lower income groups for immediate income would shift productive activities from the replacement of capital to the supply of consumption goods for immediate use. The capitalistic system seems to require a considerable degree of inequality in order that it may have the necessary capital to operate -- although the present degree of inequality is perhaps unnecessarily great. A system of death taxation that would lead to almost complete redistribution and equality of wealth would probably have a very repressive long-term effect on production.
OTHER STANDARDS: With regard to the other tax standards the death taxes do not appear to be sufficiently better or worse than other taxes to affect materially the relative merits of the tax.
CONCLUSION: The conclusion of the writers is that transfer of property at death is an especially good source of taxation, and that the desirable level of rates is limited largely by the effect on the accumulation of capital, about which little is known.
2. DEATH TAXES AS A SOURCE OF FEDERAL REVENUE
REASONS FOR CLAIMS OF STATES: States have contended for exclusive use of death taxes chiefly on two grounds, priority and state control of descent. Death taxes were introduced in a great many of the states before the federal government passed the estate tax in 1916. The control of descent is vested in the states, so that it is claimed that in effect the state is creating the tax base and should therefore tax it. The embarrassment of the federal administration in enforcing a tax resting on state laws of descent is also emphasized.
ACCIDENT OF SITUS: There are, however, strong reasons why the federal government should impose death taxes. Under Supreme Court decisions the situs of intangible property for death taxation is the residence of the descendent. A large part of most estates, especially the larger ones, is in the form of securities and other intangible property. Accordingly the situs for purposes of death taxation for a large part of the property transferred is determined by the residence of the decedent at the date of his death. This residence may have been purely accidental so far as the state is concerned. A person may have spent practically all his life in one state and earned his fortune there. Then for one of a variety of reasons he may have moved to another state, established his residence and died shortly thereafter, giving the state all of the death taxes. Luck and whim have more to do with the location of the taxable base than can be justified.
NATIONWIDE SOURCES OF GREAT FORTUNES: Furthermore most large fortunes have not been earned in any one state. Business crosses state boundaries and has become national and international in character. To locate in a specific state the power to tax a large volume of social wealth that has been created throughout the country seems difficult to defend. Taxation by the federal government whose jurisdiction covers all of the states is more logical.
STABILITY OF REVENUE: Revenue from death taxes are subject to substantial variations from year to year. This is particularly true in individual states because the number of very wealthy persons residing therein is ordinarily relatively small and accordingly the number dying from year to year is highly variable. The larger the jurisdiction is the more nearly stable the revenues are from death taxes.
FEDERAL PROTECTION OF STATE DEATH TAXES: Because of the ease of shifting the situs of intangible property for state death taxation, states formerly competed -- and still do to some extent -- for wealthy people by imposing low death taxes or none at all. The federal offset or credit of state death taxes against the federal estate tax was granted to protect states from the annihilation of state death taxes by competition.
CONCLUSION: The conclusions of the writers are that states have no valid claim to exclusive use of the death taxes, and that some use by the federal government is desirable.
3. THE RELATIVE MERITS OF ESTATE AND INHERITANCE
TAXES FOR FEDERAL USE
DIFFERENCES BETWEEN ESTATE AND INHERITANCE TAXES: Death taxes are of two types. The estate tax is imposed on the net value of the total estate regardless of how it is to be distributed among beneficiaries. The inheritance tax is imposed on the share going to each beneficiary with the rates usually graduated according to the relationship of the beneficiary to the decedent and to the amount inherited. Rates imposed on strangers to the blood and distant relatives are usually higher than these imposed on close relatives.
INCIDENCE OF THE TAXES: The incidence of the two taxes is different. The incidence of the estate tax ordinarily is on the residual claimant or remainderman. If the will of the decedent grants specific sums to various beneficiaries and leaves the remainder to one of the beneficiaries the whole tax is borne out of this remainder, since it reduces the amount of the estate available to the heirs. In the case of the inheritance tax, however, the tax is imposed on the share received by each beneficiary and reduces that share alone.
This difference in incidence can be largely nullified by action of the decedent. Careful drafting of the will with death taxes in mind can place the incidence of either the estate tax or the inheritance tax upon the heirs whom the decedent wishes to bear it. Ability to forecast the amount of the estate is necessary to do this with approximate accuracy.
Another difference between the inheritance and estate taxes is that with the inheritance tax a wider distribution of the estate among beneficiaries usually reduces the total tax, the exact effect depending on the graduation of rates. Use of the inheritance tax might thus be expected to encourage wider distribution of estates as a method of minimizing the tax.
RELATION OF TAX TO ABILITY TO PAY: Death taxes may be considered personal taxes on the beneficiaries. Personal taxes should relate as closely as possible to the total economic position or ability to pay of the individual. Neither estate nor inheritance taxes achieve this result since nothing but the transfer of the property in question is considered. However, the inheritance tax comes somewhat closer to the standards of personal taxation than does the estate tax since the personal situation resulting from the transfer is considered in the case of the inheritance tax. The ability of the decedent to determine the incidence of the tax may largely nullify the superiority of the inheritance tax in this respect.
ADMINISTRATION: The estate tax is much easier for the federal government to administer than an inheritance tax would be. Only the amount of the gross estate less deductions need be determined. The tax can be imposed and collected without regard to any quarrels over the distribution of the estate -- except as these may involve charitable bequests. The difficult problems of valuing life estates and the interests of the remaindermen are avoided. Furthermore, since the laws of descent are state laws and are administered by state officials the determination of a federal tax would be placed more completely in the hands of state officials than might prove desirable for the federal government.
CONCLUSION: The conclusion of the writers is that the administrative factor is the more weighty and that on balance the estate tax is better for the federal government than the inheritance tax although the latter comes somewhat closer to ideals of justice.
4. ESTATE TAX EXEMPTIONS
A. EXEMPTION AND TAX STANDARDS.
ADMINISTRATION: Tax exemptions are allowed ordinarily because they promote both the administrative ease and the justice of taxation. Administratively the revenue derived would not justify the application of the tax to every estate. The allowance of an exemption saves the cost of administering the tax on a large proportion of estates without seriously affecting the amount of tax revenue produced. For administrative purposes the exemption need not be of the usual type; it would suffice not to impose the tax on any estate below a certain size, while taxable estates were allowed no exemption. The result of this procedure would be to encourage those close to the taxable line to attempt evasion but otherwise the effects on administration would be negligible.
JUSTICE: Two slightly different equitable bases for exemption have been proposed. One is that taxable capacity does not begin with the first dollar of income received or property owned. A minimum for subsistence is deducted and taxable capacity considered to begin only with amounts remaining after deducting the minimum. Part of the income of the millionaire represents no taxable capacity just as does part of the income of the very poor individual.
A slightly different basis for tax exemption is merely that after payment of the tax a minimum of subsistence should be left to the taxpayer. In the case of the poor individual this minimum will correspond to the exemption of a subsistence minimum. In the case of a wealthy person, however, so long as the rates are low enough so that the amount left after the payment of the tax is more than the minimum of subsistence, no exemption is required in order to give justice. The significance of these two equitable bases for exemption will appear below in the discussion of the application of exemptions.
REVENUE: By diminishing the amount subject to tax, exemptions decrease the amount of revenue that any given set of rates will produce. Whether the exemption also decreases the stability of revenue depends on the manner in which the exemption is applied and also on the rate structure.
B. METHOD OF COMPUTING ESTATE EXEMPTIONS.
DETERMINING THE EXEMPTIONS BY THE BENEFICIARY: The application of theories of personal justice in determining exemptions for estate taxation is difficult because the size of the estate, as previously mentioned, may bear no relation to the personal situations of those to whom the estate is distributed. Estate tax exemptions ordinarily disregard the distribution of the estate. However, exemptions might be determined by the number and relationship of the dependents, an exemption determined by relationship being allowed for each beneficiary and these exemptions added to determine the total exemption allowed the estate. The taxes, however, would be computed on the estate as a unit and not on the shares of the beneficiary. Such an exemption, would protect minimum subsistence better than the flat exemption, although in the case of estate taxation the connection with a minimum of subsistence is not easy to make. Professor Walradt recommended this method of computing exemptions. /1/ He recommended an exemption of $15,000 for the widow, $7,500 for a widower, $2,500 to $3,500 for each minor child, dependent on age, $5,000 for a parent, and special allowances for disabled dependents, but no exemption for children over 21 or for other relatives. The inclusion or exclusion of different relatives was based on the legal and moral obligation of the decedent to support them. The amount allowed was calculated on the probable period of support and the minimum requirement for subsistence.
Although the computation of exemptions in this manner would improve the justice of the estate tax as a personal tax, it does not seem practicable. The difficulties of imposing a federal inheritance tax would arise in determining the exemption -- that is, knowledge of the distribution of the estate among the beneficiaries would be required. Distribution is determined by state authorities, is sometimes a matter of litigation, and is often long delayed. The increased justice that might be achieved by using this method of computation would hardly overcome the increased administrative difficulties.
However, the typical distributions of estates should have a bearing on the amount of exemption that should be allowed. The writers are of the opinion that the present exemption of $40,000 is too large in view of the typical distributions of estate. Wisconsin statistics of 192728 throw some light on this subject. With an exemption for wives of $15,000, for husbands of $2,000, and for children regardless of age of $2,000, and of smaller amounts for other heirs, the average exemption taken on estates of between $50,000 and $1 million -- large enough to insure that full exemptions would be taken -- was only $17,000. /2/
Estates of all sizes for which inheritance tax reports were filed numbered 3,315 and were distributed to 14,381 beneficiaries, or an average of 4.33 an estate. Of these 869 were wives, or 0.26 wives an estate, 405 were husbands or 0.12 an estate, 5736 were children or 1.72 an estate, 1,116 were grandchildren or 0.34 an estate, 123 were parents or 0.04 an estate, while there were 5618 other beneficiaries or 1.69 an estate. Assuming all children were minor and entitled to the $3,500 maximum, and that there were no disabled dependents, the application of Professor Walradt's figures would give the following average:
0.26 widow at $15,000 $ 3,900
0.12 widower at $7,500 900
1.72 children at $3,500 6,020
0.04 parents at $5,000 200
Total average exemption $10,200
The writer hastens to recognize the danger of absurdity in using such
average figures, since no actual estate could be so constituted.
However, the average picture does throw some light on the general
situation. It would seem that while some hardship might be caused in
the case of an otherwise penniless widow with several young children,
on the whole -- and an estate tax can do only rough justice -- an
exemption of $20,000 would be adequate.
METHOD OF APPLYING THE EXEMPTION: Some controversy has arisen over the method of applying estate tax exemptions. Three methods may be distinguished. That now in use by the federal government is to deduct the exemption from the amount of the net estate and compute the tax at graduated rates on the balance. The effect of this method is to reduce the amount of the estate taxed in the highest brackets. The exemption may be said to be taken "at the top." Its result is to give the larger estates more exemption in dollars of tax than the smaller estates. A second method in use in some states is to begin the rate schedule with the first dollar of net estate and to allow a deduction of exemption from the bottom brackets of the tax. The exemption may be said to be taken "at the bottom." Its result is that every taxable estate, large and small, receives the same exemption in terms of dollars of tax. A variation in the method is to calculate the exemption as a specified number of dollars of tax to be deducted from the tax computed on the whole estate. This plan is used in the income taxes of Wisconsin and several other states. The third method is to reduce the amount of exemption allowed as the size of the estate increases so that for the larger estates the exemption entirely disappears. This type is called the "vanishing exemption." The vanishing exemption may be taken "at the bottom" or "at the top."
Exemptions taken "at the top" have been criticized because the result is more exemption in dollars of tax to large estates than to small estates. Whether one considers it unjust is perhaps determined by his idea of the proper relation of exemptions to tax-paying ability. The two views of this relation have been previously described. The exemption "at the top" rests on the view of justice that a portion of any estate represents no taxpaying ability. This amount must be deducted from every estate, large or small, to derive the part of the estate capable of bearing taxes. The exemption "at the bottom" and the "vanishing exemption," however, rest on the view that so long as a minimum of subsistence remains to the taxpayer after the payment of taxes, the need for an exemption has been met.
With any given schedule of rates and exemptions, the vanishing exemption results in the largest amount of revenue, the yield of the exemption "at the bottom" is next in size, and that of the exemption "at the top" is the least. The higher revenues in the first two cases are equivalent to slightly higher effective rates.
While the method of taking the exemption influences the distribution of the tax burden, it does not determine it. The tax on any estate is a function of both the exemption and the rate schedule. The same burdens on any size of estate may be achieved with each exemption system by adjusting the schedule of rates to produce the desired result. /3/
In case the method of calculating the exemption were changed from the "top" to the "bottom," with no change in rates, the most obvious result is to increase the amounts of tax collected from the larger estates. The larger the estate, up to the top brackets, the greater the increase in the amount of tax resulting from the change. However, the percentage increase in the tax paid and the increase in the effective rate of tax on the estate are greater for the smaller estates than for the larger ones.
The table below illustrates the situation:
Amount of Tax
Present Present Ex- Increase Percent Increase as
Exemption emption in tax increase in Percent of
Net Estate "at top" "at bottom" amount tax Estate
$40,000 $ 0 $ 0 $ 0 0 0
50,000 200 1,000 800 400.0 1.6
70,000 1,200 3,400 2,200 183.3 3.1
100,000 4,200 7,600 3,400 81.0 3.4
200,000 19,800 24,600 4,800 24.2 2.4
500,000 80,400 87,600 7,200 9.0 1.8
1,000,000 211,000 220,600 9,600 4.6 1.0
10,000,000 4,936,600 4,960,600 24,000 0.5 0.2
50,000,000 32,335,000 32,360,600 25,600 0.1 0.05
In the table it is seen that the change in exemptions from the "top" to the "bottom" increases the taxes of the $50 million estate by $25,600 as compared to $800 for the $50,000 estate. However, this increase is only 0.1 percent of the total tax of the $50 million estate while the increase in the tax on the $50,000 estate is 400.0 percent. Similarly, although the increase in the effective rate (that is, the percent of the total tax to the total net estate) is 1.6 percent of the $50,000 estate (and 3.4 percent of the $100,000 estate), it is only 0.05 percent of the $50 million estate.
The effect of changing from exemption at top brackets to exemption at bottom brackets is thus more than merely requiring larger estates to pay a higher total tax. The progressive rate scale is altered, with relatively greater increases taking place in the smaller estates. Effective tax rates are also increased more in the smaller estates.
The real significance of differences in exemption methods is perhaps political: by substituting vanishing exemptions or exemptions at the bottom for exemptions at the top a somewhat higher effective rate may be imposed without changing the nominal rate schedule. In case higher estate tax revenues are desired, a shift in exemptions may be politically easier to accomplish than a shift in rates.
EXEMPTION OF INSURANCE: The exemption of insurance up to $40,000 violates principles of tax justice by preferring one type of asset to another. The writers see no valid reason for continuing it and recommend its elimination.
5. RATE LEVELS AND RATE STRUCTURES
Four principles may appear to be influential in determining an estate tax rate structure. The first is that no real hardship should be caused those for whose support the decedent was legally and morally responsible. The second is that the rate structure should recognize the desirability of a middle class of fairly wealthy people as distinguished from a class of very wealthy people. /4/ A third is that the rates should be so designed as to place an upper limit to the size of fortune that can be passed on for several generations without being replenished from other sources such as personal earnings. The fourth is that rates of tax should not be so high that discouragement of saving offsets benefits of the tax. The first of the principles is related to justice among persons, while the other three are factors of social and economic control. Obviously these four principles are not necessarily in harmony with each other and are probably always somewhat conflicting. Furthermore, they do not furnish much assistance in constructing an actual schedule of rates.
The principle that no real hardship should be caused those for whose support the decedent was legally and morally responsible is met by allowing an exemption and by imposing relatively low effective rates on the smaller estates. The desire to preserve a middle class of fairly wealthy people is met by not jumping the rates immediately to the highest brackets but rather increasing them gradually. Placing a limit on the size of fortunes is achieved by setting the effective rates on large estates so high that the ordinary income of an estate during the average lifetime of its holder will not be sufficient to pay the tax at his death. It may also be achieved as will be explained below by making some distinctions between a first generation transfer and a second generation or later transfer.
The most difficult principle to apply is the one relating to tax on the growth of social capital. Clearly the high rates of estate tax diminish the rate at which social capital may increase. Even a small amount of this effect may be in itself socially undesirable, so that from this particular point of view even an increased degree of inequality in wealth might be viewed as desirable. However, in this connection should be noted the question raised by some whether an indefinitely large increase in the volume of social capital is possible, when due to monopoly, refusal to invest capital at low rates of return, or for some other reason saving does not result in investment in new social capital.
Even though the promotion of saving may be desirable, the revenue and social control results, as well as the revenue derived from the estate taxes, tend to offset the harm done through discouragement of capital growth. At some point, however, the disadvantages of slowing up capital growth will become more important socially than the revenue or desirable controls of the tax. That point sets the upper level beyond which rates should not go. Determination of the actual point is perhaps impossible for several reasons. First, determination of the actual effect of the tax on saving and accumulation is not easy. Second, the relative weights given in the minds of the people to the social advantages of heavy estate taxation as compared to the increased productivity that might result if the tax were not used vary from person to person and are not ascertainable by scientific research processes. The problem is a political one to be determined by a well-informed public opinion. In the opinion of the writers the estate taxes are much too low in what may be called the lower and middle brackets. It is believed that a very substantial increase in rates can be made without serious effect on the development of social capital and without hardship to dependents of the decedent. It is the belief of the writers that the upper rates are quite high enough at the present time both from administrative and economic viewpoints and that no increases in these brackets should be made now. The maximum rates of taxes (including all taxes) at the present time are high enough to prevent in some cases an estate being passed on unchanged from generation to generation. /5/ Some study should be given to the size of the estate at which this is true and to the desirability of adjusting tax rates to lower the size.
It should not be gathered from the above remark that the use of the estate tax is primarily for the purpose of effecting social control although undoubtedly this purpose will loom large in any estate tax program. Another important point is that high estate tax rates may be made to yield a very substantial amount of revenue. It would perhaps surprise the average person to know that, despite all the publicity and all the arguments for and against the tax, the total of federal and state death taxes is less than the yield of the federal liquor taxes.
Politically, the present appears to be a very good time to seek higher estate tax rates. Even the more conservative groups in society have been the source of expressions of condemnation against the passing of huge estates from one generation to another. This is a relatively new attitude and it cannot be expected to continue permanently without some setback for at least a time.
The writers approve in the main the rates proposed in Tax Revision Studies, 1937, volume V, p. 23 ff. The proposed totality form of rates interrupts the smoothness of the progression but may be justified by the improved public consciousness of the true burden. However, any totality rate scale should be accompanied (although not in the statute) by a bracket schedule showing the equivalent changes made in bracket rates by the law.
6. THE RIGNANO PLAN
A plan that has been suggested to prevent the transfer of a large estate from generation to generation indefinitely and yet not to discourage accumulation is the Rignano plan. The basic idea of this plan is to distinguish two parts of every estate, one comprising the value received by previous inheritance, the other comprising additions to the estate made by the decedent. A very heavy tax would be imposed on the first part and a relatively light tax on the second part. Proponents contend that while a person may accumulate for his children, he will hardly be influenced by distant generations.
Little analysis has been made of this plan to determine the applicability to American conditions. It is so radical a departure from present practice that no recommendation concerning it is made. However, the plan appears to contain merit and should be examined in detail as a possibility for future estate tax reform.
7. THE DESIRABILITY OF GIFT TAXES
The present federal gift tax law in the United States is intended as a supplement to the estate tax rather than as a tax imposed for its own sake. As the estate tax is increased in rate, the inducement to dispose of property by gift likewise increases. The gift taxes were intended to diminish or eliminate this inducement to avoidance.
Gifts add to the ability to pay of their recipients and might justifiably be taxed as a part of income. However, since they are not payments made for services rendered, their taxation to the recipient would logically be accompanied by a deduction from the income of the donor. Such deduction by the donor in the income tax would probably mean a net reduction in the amount of income tax collected and would constitute an additional encouragement to make gifts. Gifts might be taxed to the recipient and not permitted as a deduction to the donor on the ground that although they are not net income they represent ability to pay. Since, however, from the viewpoint of public interest the only objection to gifts is the evasion of death taxes, the existing approach appears to be the logical one.
8. THE INTEGRATION OF GIFT AND ESTATE TAXES
The operation of the existing gift tax does not really eliminate or greatly diminish the inducement to avoid the estate tax by inter vivos gifts. In the present law the first $5,000 of gift in any one year to any one person is not counted as a gift for tax purposes. Amounts of gifts beyond this amount are cumulated from year to year. An exemption of $40,000 is granted as in the estate tax. The gift tax rates in any bracket are three-fourths the estate tax rates. The tax paid in each year is the excess of the tax computed on the total aggregated or cumulated sum of net gifts both for the present year and for past years over the tax paid in past years on gifts similarly computed. The effect of this procedure is to accumulate the gifts, taxing all gifts made after passage of the act as a lump sum at progressive rates. This prevents avoidance of the higher gift tax bracket rates by distribution of the gifts over a number of years.
If the whole estate were distributed in gifts before death, the total gift taxes collected would be approximately three-fourths of the estate tax that would be imposed if the estate were distributed at death. The imposition of lower rates on gifts than on estates has a logical basis since the interest on the gift tax over a period of years may amount to the difference between gift and estate taxes or even more. However, if the gifts are given shortly before death the interest on the tax is not sufficient to equalize the gift and estate tax rates.
The failure of the present gift tax to act as a real preventive of estate tax avoidance arises from the fact that both taxes start with low rates and increase progressively. The saving in estate taxes from making gifts is in the highest bracket applicable to the estate while the taxes paid on the gifts themselves are bracketed from zero upwards. Also, there are two sets of exemptions, one for gift taxes and one for estate taxes. Accordingly, if only part of the estate is given during life the amount saved in estate tax may greatly exceed the amount paid in gift taxes.
The only method that appears capable of achieving the desired result of substantially equalized taxes is to carry the accumulation of gifts one step beyond the present law and to add them to the amount of the estate actually left at death. The tax would then be computed on the total gifts at the top bracket. After deducting the gift taxes actually paid during the life of the decedent, the balance would be the gift tax due at death.
For purposes of discussion it is assumed that this method would be constitutional although doubt exists whether it would be. If it is unconstitutional, the writers recommend that the constitution be amended to make it constitutional.
Some contend that if gifts may be added to the estate in determining the rate of tax applied to the gifts, a better method would be not to tax them until the time of death and then levy the tax on the combined amount of estate and gifts at that time. However, this procedure is subject to the defect that in case nearly all of the estate was given away during life, no funds might be available after death to pay the tax. The accumulated gift tax plan previously described is not subject to this defect. The larger amount of the estate given away during life, the larger the amount of gift taxes collected. The tax at death will never be so large as to take the remainder of the estate. However, because of the additional taxes that may be imposed at death due to the adding of gifts to the estate the amount of tax collected at death may constitute an extremely large portion of the remaining estate. Under some circumstances this might result in hardship.
Another method would be to value the whole property of the giver at the time the gift was transferred and impose the gift tax at the top bracket instead of at the bottom bracket. The more that was given away, assuming no replacement of funds in the estate, the lower the tax rates applied to succeeding gifts. Each gift could stand separately from all other gifts and be taxed at rates determined by the value of the total property of the giver at the time of the gift. Aside from the constitutional question that might arise in basing gift tax rates on the amount of property owned, the procedure would have almost impossible administrative difficulties. An inventory would have to be made of the total property of every person making a gift large enough to be taxed. This would not only constitute an almost intolerable intrusion into private affairs but would be extremely difficult to do. It would have to be repeated every time a gift was given. For this reason the plan is not feasible.
9. FEDERAL-STATE RELATIONS REGARDING THE DEATH TAX
Four policies that might be followed in relating the federal estate tax to the state death taxes deserve discussion at this time. The first is to leave the 80 percent credit of state taxes against the federal tax as computed under the rates of 1926 without change. A second is to repeal the 80 percent credit provision. A third is to extend the 80 percent provision or some lower percentage to the whole federal tax. The fourth is to substitute or supplement the credit by sharing the federal revenue from the estate tax with the state.
The continuation of the 80 percent credit against the federal tax as computed under the rates of 1926 has two disadvantages from the viewpoint of federal-state relations. The first is that the 1932 and later rate increases on smaller estates have increased federal but not state revenue, so that the federal government now receives a larger proportion of the tax paid on small estates than of the tax paid on large ones. This is contrary to the idea that small estates are usually more localized than large ones and that accordingly state taxes are more suitable on small estates. The second disadvantage is that the increases in federal rates suggested in this memorandum will decrease the revenues collected by the states since the federal estate tax is deducted before computing state inheritance taxes.
The repeal of the 80 percent credit provision would strongly tend to make the federal tax the only death tax, since the same forces of state competition that gave rise to the 80 percent credit in 1926 would again be active. Federal revenue would be increased by at most the $100 million states now collect. /6/ In view of the fact that states can administer death taxes successfully, that they have the claim of prior use and that their revenue needs are acute, repeal would be unfortunate.
The extension of the 80 percent credit provision to the currently existing and recommended rates would probably lose the federal government more revenue than the recommended rate increase would gain. Furthermore, it would mean an increase in state taxes on estates of largely national character, which are more logically a source of federal revenue.
The proposal to grant a share of the federal revenue to states repealing their taxes is made presumably as a method of bringing uniformity among states and reducing administrative costs. However, it constitutes a radical change in federal-state relations. Some reason exists for believing that such a change should not be made except as part of a general reorganization of federal-state relations in all tax fields. If the concession of federal sharing of revenue is made, it may not be available as a bargaining point to secure concessions by the states at other points.
Perhaps a better approach would be to change the calculation of the federal credit so that it applied to the recommended rates instead of to the 1926 rates, allowing a larger credit in the case of the fairly small estates than in the case of the very large ones, the total fiscal result to be about the present division of revenue between state and federal governments.
One reason for making no change at all at the present time is to await a general study of intergovernmental fiscal relations. Change now would tend to reduce the probability of thoroughgoing results coming from such a study. The present writers are inclined to this view and do not recommend any changes in relations between the federal government and the states at this time in regard to death taxes.