A Stitch in Haste

Matthew Yglesias is — as usual — 100% wrong when he tries to rationalize the death tax by re-labeling it as an “inheritance tax.”

I might be an earnest, hardworking dude who works in the store. And somebody might die and give the store to me. The store may be worth millions and millions of dollars. If so, I ought to pay tax on it. Why? Because I've just inherited millions and millions of dollars, that's why. That I'm earnest and hardworking, and that my riches came in the form of a valuable store rather than a heaping plate of gold matters not a whit.

This is, of course, utter nonsense.

Two logical fallacies. First is the blanking out of the fact that the income tax is, at its core, an accrual tax, not a transfer tax. For example, yes I pay income tax on my salary, but that taxation process is, conceptually, offset by the deductibility of my salary to my greedy Swiss bank employer. One must add “conceptually” because the offset is of course not dollar-for-dollar (due to the different tax rates I and my employer face, as well as by my personal exemption and other bells and whistles that are overlaid onto the core income tax structure). The offset (i.e., “my taxable income is my employer’s tax deduction”) is a procedural one, not a financial one. But procedure is what matters, because in taxation, as in all aspects of the law, fair procedures help to ensure fair outcomes.

By the same token, my greedy Swiss bank employer pays taxes not on its revenues but on its profits. I pay tax not on the proceeds of my stock sales but on the gains from them. I pay tax not on the money in my bank account, but on the interest it generates. And so on.

Which is why taxing a death transfer, whether one glibly renames it from an “estate tax” to an “inheritance tax,” is completely antithetical to the underlying income tax framework. As perverse as it may be to libertarians, taxation is based on creation of value. But the creation of value is not the same as the mere transfer of value, which should, in a sane world, be a tax-neutral event. We might tax the creation of a pizza pie, but we do not tax the shuffling around of slices among gramps, dad and the kids. Nor should we tax the pizzeria for no other reason than because gramps died. It simply defies all common sense.

The second logical fallacy of the death tax is what one might call the “double jeopardy” principle of taxation. The wealth in an estate has already been subjected to the taxation process. It is fundamentally unfair, Rawls or Yglesias notwithstanding, to subject it to a second taxation process.

“But Kip, you’re cheating! Often the value in an estate has not been taxed. For example, money in a 401(k) account is not taxed until it’s withdrawn at retirement, so if that account passes through an estate before the decedent could withdraw it, then it escapes income taxation. That’s not fair!”

Um, no. Notice that I said “subjected to the taxation process,” not “subjected to tax.” My income from my greedy Swiss bank employer is, in total, subjected to the income tax process the moment I receive it — every single dollar of it, even the dollars that are diverted into my 401(k) and therefore not immediately taxed. If I happen to use the various provisions of the income tax rules to shield income from taxation, then it has still been subjected to the taxation process. Stated differently, if I’m playing by the rules today, then why should I be punished for that tomorrow?

Just as the income that escapes taxation from the assorted exclusions, exemptions and deductions of the Internal Revenue Code are subjected to the income taxation process even if they are not actually taxed, so too with accumulated wealth in an estate: it may never have been taxed, but it was subject to the taxation process long before the decedent passed away. Therefore, it is unjust and unjustifiable to subject it to a second taxation process.

When enough people play that game called “The American Dream,” some of them are actually going to win. It takes a sick mind to think that’s somehow a bad thing that needs to be “corrected.”

More thoughts from, Truck and Barter, Outside the Beltway and Isaac Schrödinger.