Inheritance tax systems can play an important role in increasing social equality, yet across the world, these systems often struggle to achieve their intended aims. Étienne Fize, Nicolas Grimprel and Camille Landais outline four key ways in which they can be improved and reformed for modern conditions

Fize, Étienne

Grimprel, Nicolas

Landais, Camille

English

LSE Research Online

Reforming inheritance tax systems: Fourguiding principlesInheritance tax systems can play an important role in increasing social equality, yetacross the world, these systems often struggle to achieve their intended aims. ÉtienneFize, Nicolas Grimprel and Camille Landais outline four key ways in which they can beimproved and reformed for modern conditions.There is a strong case to be made that inheritance taxation is desirable both from aneconomic and normative standpoint, as we argue in a recent study. We are in a uniquehistorical period where restoring progressivity in the taxation of inheritance flowsappears critical to prevent the extreme concentration of wealth at the top, thesolidification of a dynastic class of rentiers, and the demise of social mobility along thewealth distribution.Yet, faced with such urgency, the inheritance tax systems of most western economiesare failing on all fronts. They are achieving less and less in bringing about a moreequitable society in major liberal democracies, and yet incurring substantial unpopularityat the same time. One indicator of their increasing lack of traction is shown in Figure 1,where it is apparent that the once-substantial equalising impact of inheritance taxation inGermany, France and even the United States circa 1970 has long ago dissipated – whilein the UK the tax’s impact was always rather slight.Figure 1: The evolution of inherited wealth as a share of total wealthPage 1 of 5Permalink: undefinedDate originally posted: undefinedDate PDF generated: 01/12/2022Note: Simplified definitions using inheritance vs. saving flows; approximate lower-boundestimates. Source: Alvaredo, Garbinti and Piketty (2017)It is clear that inheritance taxes have failed in hindering the return of inheritance as themain driver of individuals’ wealth rank in society. In addition, they have failed at beingtruly progressive, with people in the top of the inherited wealth distribution benefitingfrom various unjustified tax loopholes.Finally, they have failed to be accepted and truly understood by the public, both in termsof their aim and functioning. Most inheritance tax systems are therefore broken andunable to cope with the task. Unless they can be greatly improved and reformed, there isa very real risk that more countries will engage, like New Zealand (in 1992), Sweden (in2004), or Austria (in 2008), in abolishing estate or inheritance taxation altogether.We propose four general principles that would make inheritance taxation more efficientand transparent, while restoring its intended progressive effects: switching to a systembased on total lifetime inheritance flow, instead of taxing each transmissionPage 2 of 5Permalink: undefinedDate originally posted: undefinedDate PDF generated: 01/12/2022independently; eliminating most tax loopholes, especially those that do not beareconomic justification, and reinforcing the effective progressivity of the inheritance taxschedule; redistributing generated tax revenues as a wealth endowment for all toalleviate inefficiencies generated by credit constraints and allowing for productiveinvestments at the bottom of the wealth distribution; and creating an efficient andtransparent information system to assess and adjust the inheritance tax system overtime.Taxing lifetime inheritance flowsInequalities in the wealth inherited by individuals over their lifetime are extreme. Theyare also much stronger than the inequalities that one may observe from annualinheritance transfers in isolation. This is due to the richest heirs tending to receivenumerous transmissions of similar value throughout their lifetime.These transmissions generally come from several family members, and are split intoboth donations and inheritance. The current inheritance tax systems of most westerneconomies, because they tax each transmission independently, allow the richest familiesto optimise the timing of transmissions and benefit several times from the tax exemptionthreshold in place.The independent treatment of each transmission plays an important role in explainingthe gap between the very progressive tax scale displayed, and the much lower effectivetax rates incurred by individuals at the top of the wealth distribution. It also unfairlypenalises individuals that receive fewer or more uneven transmissions, and thereforefeeds into the unpopularity of inheritance taxes among the public.Switching to a system based on total lifetime inherited wealth, rather than individualtransmissions, would prevent such timing optimisation on the part of the richest families,while making it fairer to people receiving fewer and/or more uneven transmissions. Itwould also permit a less aggressive tax scale, with a higher exemption threshold, andmake the system more transparent to the public by reducing the gap between the taxscale displayed and the tax rates effectively incurred.In addition, a system based on lifetime inheritance would eliminate the distinctionbetween direct and indirect transmissions, and also distortions in the timing ofPage 3 of 5Permalink: undefinedDate originally posted: undefinedDate PDF generated: 01/12/2022transmissions. Several countries, such as Ireland, have already successfully switched toa lifetime-based system. Building on these first experiences, we also know that the moveto a lifetime-based system does not require heavy technical adjustments, conditional onbeing able to record individuals’ total inherited wealth over time.Eliminating tax loopholesIn the United States, inherited estate wealth of more than a million dollars faces amarginal tax rate of 40%. In France, the marginal tax rate for direct transmissions above€900,000 is 40%, and 45% for wealth exceeding €1.8 million. Yet, the effective tax rateincurred by individuals at the top 0.1% of the inherited wealth distribution hardly reaches10% in France, despite these individuals inheriting on average €13 million over thecourse of their lives.There is no strong economic argument for taxing life-insurance at a lower rate relative toother types of transmitted wealth. Life-insurance should be integrated into the generalinheritance tax regime. Similarly for trusts, the tax exemptions and/or rebates in place donot provide any credible efficiency gain, while almost exclusively benefiting the top of theinherited wealth distribution. Taxing transmissions through trusts should be done in thesame way as any other type of transmitted wealth.Using inheritance tax revenues to fund wealth endowments for allGuaranteeing a wealth endowment for all is desirable for both equity and efficiencyreasons. Providing a wealth endowment to individuals with no or very little wealth wouldreduce the severe inequalities observed at the bottom of the wealth distribution.Such a wealth transfer would also alleviate inefficient credit and liquidity constraints thatprevent productive investments in education, businesses, or housing. The benefits ofthis reform explain why it has frequently been put forward by economists. Such a systemcould be based on citizenship at birth, and the wealth transfer to all citizens could bemade when individuals reach the age of 18 or 25, or at the time of the first receivedtransmission.To really alleviate liquidity and/or credit constraints, the wealth transfer also has to belarge enough. Previous research shows that small transfers of wealth do not allow poorPage 4 of 5Permalink: undefinedDate originally posted: undefinedDate PDF generated: 01/12/2022individuals to sustainably invest and to consequently escape poverty. This poverty trapmotivates our argument for a large, one-off wealth transfer, rather than for monthly oryearly benefits.The transfer should also not be conditioned or constrained in its use. Paternalisticconcerns that the acquired wealth would be ‘misused’ or affect individuals’ labour supplyare not supported by the empirical literature. And of course, such concerns are rarelyraised when it comes to wealth transfers at the other end of the wealth distribution.Building efficient and transparent information systemsThe three suggestions above can all be implemented independently from one another.Yet all of them require an efficient and transparent information system. A lifetime-basedinheritance tax system must be able to track individuals’ accumulated inherited wealthover time.Reducing the scope of tax loopholes and preventing abuses implies that the taxauthorities will have sufficiently precise data on individuals’ inherited wealth in order toeffectively conduct monitoring and inspections. Redistributing the tax revenue as wealthtransfers requires being able to effectively estimate the revenue generated byinheritance tax.Moreover, these transfers can only be targeted to the bottom of the wealth distribution ifindividuals’ full wealth is being precisely recorded. Finally, an efficient and transparentinformation system is necessary to be able to predict and evaluate the effects of thereforms, and to adjust the system as required.For more information, see the authors’ accompanying study in LSE Public PolicyReview’s November 2022 issue on Tax JusticeNote: This article gives the views of the authors, not the position of EUROPP – EuropeanPolitics and Policy or the London School of Economics. Featured image credit: KellySikkema on UnsplashPage 5 of 5Permalink: undefinedDate originally posted: undefinedDate PDF generated: 01/12/2022

Reforming inheritance tax systems: four guiding principles

http://eprints.lse.ac.uk/117462/1/europpblog_2022_11_25_reforming_inheritance_tax_systems_four_guiding_principles.pdf

Reforming inheritance tax systems: four guiding principles

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