We all know the famous saying by Benjamin Franklin, “In this world, nothing is certain except death and taxes.” But what is less commonly known is the historical relationship between death and taxes, as well as the macroeconomic and societal implications of said relationship.
The passage of the 16th Amendment allowed the Federal Government the power to levy a federal income tax, which subsequently led to the Revenue Act of 1916, establishing the estate tax. Since then, the tax has endured many changes, including both the tax rate, exemption, and top bracket (visible in Figure D).
To most, the estate tax could not be further from relevance. That is, until politicians become involved. The common rhetoric surrounding the estate tax has preyed upon the common misconceptions surrounding the tax, most specifically, that the tax has significant impacts on the working class. Under that rhetoric, the exemption increased to $5 million in 2010, and again to $11 million in 2018. Considering that the average net wealth left to heirs clocks in at around $296 thousand, it is quite fair to say that the politicians effectively duped the nation.
Why this exemption—along with the decrease in estate tax rates—is so significant is not just for the revenue implications of the tax (see Figure 1), but also for the effect it has on how the wealthy manage their assets.
When paired with the capital gains tax, a tax applied to the amount realized from the sale of an asset, the estate tax changes have created an environment in which wealth transfer for the wealthiest is the easiest since the beginning of the 20th Century. See, for the amount leading up to the estate exemption, an individual is incentivized to hold their money, as their choice is either hold and utilize a generational transfer of wealth, or sell and be subjected to the capital gains tax.
This creates an interesting paradox for more modest high net-worth individuals as their holding of wealth both decreases liquidity into the markets, and further contributes to the generational wealth-gap (inheritances account for about 40% of all household wealth and are extremely concentrated at the top).
The bottom line: an immensely-large wealth gap that has socio-political implications that could significantly alter the structure of the U.S. and its economy. The clearest cut solution remains to raise the estate tax and lower the estate tax exemption, while leaving the capital gains tax for further analysis. The whole goal of reforming the estate tax is to increase liquidity into the markets. In a time where inflation is such a massive buzz-word (and rightfully so), it benefits society to better utilize its existing monetary assets rather than attempt to artificially stimulate its economy at a higher clip than already present.
Not Financial Times (NFT) is an Opinion column created by Roshni Revankar ‘22 to share insights and research into students’ favorite companies, industry trends, and anything in financial markets that really irks their curiosity.
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