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The Estate Tax and Capital Decumulation

Shocking! Outrageous!

Matt Yglesias writes about the estate tax. I don't read him often, and this sort of article is why. (Also, Paris Hilton is mentioned.) I hoped that someone in his comments would have something substantive to add, but I gave up halfway through. There is a very straightforward, easy to understand reason why the estate tax is a bad tax. I'll go so far as to argue that it is the worst possible kind of tax and ought to be completely and permanently abolished.

First, let's see what I'm up against. After stating his preference for inheritance tax instead of estate tax (I see no substantive difference), he says:

Speaking of which, fuck the small businessman. This is exactly the problem posed by obsessive focus on Paris Hilton. 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. What about those sad folks forced to sell the family business? Don't cry for them. Here you are, you inherit a store worth $X. You owe $Y in taxes, with Y being less than X. So you are "forced" to sell the store, and accept "only" $X-Y as your inheritance. Note that X is a figure in the millions, and Y a small proportion of X. This is a very good problem to have, abstracting away from the fact that someone you love has probably died and this is probably a bigger concern of yours that the tax bill. This is, in other words, a non-problem. The government ought, perhaps, to facilitate some kind of lending arrangement so that people who prefer to keep the store and pay the tax down over time out of operating revenues can do so.

What kind of thought process creates this sort of drivel? Megan McArdle had it right in her brief post (h/t) saying "Matthew Yglesias ably demonstrates why middle America hates blue state folks like us." But she also didn't say what was wrong with it. And after reading about a third of her comments, none of them had hit upon it either.

Perhaps, then, what I'm about to say is a uniquely Austrian perspective. (Megan's audience tends Chicago school. Matt's is &hellip not economic.)

The estate tax is a bad tax because it forces capital decumulation. It does this very purely. Unlike income or sales taxes, the estate tax's effect on capital doesn't occur at the margin, with dollars that aren't yet or are only barely invested. The estate tax gouges deep into existing capital. Even a small percentage of a business with several million dollars in assets is a very large tax and can easily require the sale of the business, or the acquisition of a large debt to avoid sale.

No matter how financed, the tax is a large chunk of money headed to the government all at once. Large chunks of money do not come from current wages or profits. They come from savings accumulated over time — i.e., capital.

(Are property taxes similar in this respect? Yes, somewhat. They are not as bad because they are much smaller and are regular, so the funds required to pay them will not become invested in long-term projects to begin with. The accumulation and then decumulation of capital is more wasteful than simply not making long-term investment in the first place. Property taxes can also be somewhat justified as a form of usage fee for government defense services. But don't get me started on public schools.)

To make the capital decumulation point clear, I must stress that there is a decumulation of capital even if the business is not liquidated. The funds that enabled the business to stay whole came from a partial liquidation of some other business. Large chunks of money are productively invested (are capital), and are not found lying around idly.

The capital markets play an important role in minimizing the amount of real capital decumulation, but they would have to be perfectly efficient in order to make the estate tax's effect on capital similar to the income tax's effect on capital. (This impossible state of affairs would be represented by financing the estate tax by selling shares of the affected business only to people purchasing them out of current income.)

Capital decumulation as the explicit policy of the government is a dagger at the heart of the economy. Capital is a major factor raising the productivity of labor (the other is specialization) and this higher productivity is what makes us all wealthy. The estate tax forces capital decumulation, lowering the productivity of labor, and reducing our wealth compared to what it would be without an estate tax.

That is why the estate tax is bad. It makes us all poorer. Briefly adopting Matt's tone: government financing be damned.


I was about to mention how wonderful it feels to write a post purely about economics, rather than about politics or …taxes. Oops. This whole thing is about taxes. But at least it's from an economic angle, rather than the personal finance angle. So it didn't feel like I was writing about taxes. :)

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