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Volume 15, Number 10
The Family-Wrecking Tax
by Timothy Terrell
Among the tax discussions on Capitol Hill this year are the proposed changes in the 80-year-old inheritance tax. Part of the Republican tax plan calls for an increase in the estate tax exemption from $600,000 to $1,000,000, with considerably larger exemptions for farmers and other small business owners. The less generous Clinton Administration proposal would provide low interest rates on estate taxes paid in installments.
This debate occurs on the threshold of the largest wealth transfer in U.S. history. Some $5 to $10 trillion in assets belonging to the generations preceding the baby boomers are soon to be transferred, and the government is drooling at the revenue possibilities. Since changes made in 1987, each taxpayer has been permitted to pass on $600,000 tax free at death. But after that first $600,000, hefty estate taxes kick in, taking 37 percent to 55 percent of everything that's left.
Inheritance taxes only account for a small portion of federal revenues, totaling about $12 billion last year, or about 1 percent. But relatively small amounts of revenue collection can still have a wide-ranging social impact. Inflation has steadily brought that $600,000 figure closer to home for more Americans every year. This year, 7 percent of U.S. households have over $600,000 in assets, up from 4 percent 10 years ago.
Curiously, the worst effects of the inheritance tax are rarely discussed. The estate tax penalizes families that have a future orientation, which sends repercussions throughout the whole economy. Not only do these taxes discourage the long-term investment necessary for a high level of economic growth, but they prevent families from accumulating, over several generations, the resources required for starting a family business or for preparing for uncertain times ahead. This lowers the standard of living for everyone in the long run.
The great economist Joseph A. Schumpeter, writing in 1942, argued that the long-run interests of society depend upon the "family motive." This is the tendency of businessmen-investors to put off consumption to build up family capital over generations. Government, however, takes a short-run view and seeks to tax this accumulated wealth away from families, with disastrous results.
"With the decline of the driving power supplied by the family motive," Schumpeter wrote, "the businessman's time-horizon shrinks, roughly, to his life expectation. And he might now be less willing than he was to fulfill that function of earning, saving, and investing even if he saw no reason to fear that the results would but swell his tax bills." He then drifts into an anti-saving frame of mind which leads to ineffectiveness and apathy among businessmen, and "decomposes the motor forces of capitalism from within."
In addition to destroying economically crucial high-powered wealth, the tax is a major cause of family and social disintegration. It renders ineffective the natural obligations that preserve and solidify parent-child relationships.
Generations have mutual responsibilities to one another. These entail parental provision for the needs of young children, and the grown children's provision for aging parents. For thousands of years, the family covenant has been fulfilled by transferring wealth from generation to generation, forming relationships that are central to the survival of any civilized society.
The parent-child relationship is more than an emotional bond; it is also moral, intellectual, and financial. Parents have an incentive to train children to be wise in business matters, to save, and to give generously to others, so that wealth turned over to the children will not be poorly invested or squandered.
The inheritance is the reward for behaving wisely and caring well for their parents. Reinforcing the moral obligations of children is the implicit threat of disinheritance for gross misconduct or for neglect of their responsibilities to their parents.
The best time for parents to train their children in moral conduct and faithfulness to their filial duties is while they are under the parents' roof. If the children grow up and leave home unimpressed with what they have been taught, the parents can still have a positive impact on them by offering the inheritance as an inducement to good behavior.
But confiscatory estate taxes undermine and destroy these natural relationships, even causing chaos to erupt in the family. They encourage filial disloyalty and misbehavior. They remove much of the impetus behind a parents' transfer of intellectual capital to a child. They compromise the ability of the parents to impose consequences on bad behavior, and children grow up ignoring their obligations toward their elders.
It's no wonder so many elderly people in this nation are neglected by their children and grandchildren and left to the care of complete strangers. Children are growing up isolated from their elders, ignorant of their family heritage, and disrespectful of the ideas and traditions their parents and grandparents hold dear.
Government presumes that its legions of bureaucrats can manage accumulated family fortunes more effectively than can the families themselves. But government cannot obtain the detailed, situation-specific knowledge necessary to make wise decisions about how to spend a family fortune. Family fortunes should be handled as the family, and no other, sees fit.
The Republican plan for reducing estate taxes is a move in the right direction, but it is insufficient. At current rates of inflation, the proposed 67 percent increase in the exemption will be completely consumed in 10 to 12 years.
What is really necessary, to encourage economic growth and to preserve the natural workings of the family, is an immediate repeal of the estate tax.
Timothy Terrell teaches economics at Liberty University