A massive transfer of wealth is underway and will accelerate in the coming years. Baby boomers and the generation that preceded them currently own $84 trillion, or 81 percent of all U.S. household wealth — wealth that will before long be inherited by their children and other beneficiaries.
This extraordinary transfer of resources will further cement the economic inequality that plagues the United States because this wealth is tightly concentrated in the hands of a few. And it will be passed on as taxes on such transfers are at historic lows.
Among high-income countries, the United States has one of the lowest levels of intergenerational economic mobility, meaning a child’s economic future is heavily influenced by his or her parents’ income. We have the second-highest level of income inequality after taxes and government transfers, and the highest level of wealth inequality. These disparities are sharply skewed by race. Median black household wealth is only 9 percent that of white households, a racial wealth gap that is even larger than in 1968. New research suggests the pandemic will further increase wealth inequality, as the affluent save more and the poor earn less.
Effectively addressing these systemic inequalities will require many things. But increasing the taxation of inheritances is one vital component.
This year, Americans will inherit about $765 billion. People who were already rich will inherit a lot more than people who weren’t wealthy. So will white households; they are twice as likely as black households to receive an inheritance, and receiving an inheritance is associated with an increase in wealth that is 26 times larger for white families than for black families. (This accounting of inheritances includes gifts and bequests, other than those to spouses or to support minor children.)
Roughly 40 percent of all household wealth stems from inheritances. This means that 40 percent of why some Americans are extraordinarily well off has nothing to do with smarts, hard work, frugality, lucky gambles or entrepreneurial ingenuity. It is simply because they were born to rich parents.
Inheritances compound over generations, one reason societies often choose to tax them as a way to combat rising inequality and level the playing field. Our tax system has always been one of our most potent tools for expressing and acting upon our values. But in this area, it is failing and only getting worse.
Consider a wealthy couple who bequeaths $50 million to their son. The couple will probably not have paid income or payroll tax on a large share of the bequest, thanks to a provision called stepped-up basis, which exempts gains on bequeathed assets from tax. Their son can exclude the entire $50 million he receives from his income and payroll tax returns.
The estate tax was meant to partially correct for these omissions. Indeed, it is the only tax that will apply to the son’s inheritance. But over time Congress has hollowed out the estate tax and its cousins, most recently in the 2017 tax law. Today, the first $23 million that a couple transfers is entirely exempt from the estate tax. Amounts above that threshold are taxed only at a 40 percent rate.
As a result, the effective tax rate on this lucky heir’s $50 million inheritance will only be 21 percent. And that’s if his parents didn’t use any estate-tax planning techniques to reduce his tax burden. If they did, his tax rate could easily approach zero.
Some will argue that this example ignores any income and payroll tax the wealthy parents paid when they originally earned the $50 million. But if the couple paid their personal chef’s wages out of after-tax income, we wouldn’t think their personal chef should get credit for the taxes they paid. Similarly, we should ignore any income or payroll tax the couple paid when considering how much their son should contribute to the costs of government.
Combining the effects of estate, income and payroll taxes, the average federal tax rate on income in the form of inheritances is a minuscule one-seventh of the average tax rate on income from saving and good old-fashioned hard work.
A fairer tax system would tax inheritances at higher rates than income from working, not lower. Someone who inherits millions is better off than someone who had to work for their millions because, let’s face it, most of us would rather not work. Moreover, wealthy heirs are better off because typically they can earn much higher salaries if they do work, benefiting from the education, connections and safety net available to those from well-off families.
A large body of research also finds that wealth transfer taxes do relatively little to reduce the amount of work, saving and entrepreneurship by donors. Meanwhile, such taxes increase work by heirs and charitable giving. This research suggests that the optimal tax rate on very large inheritances is between 60 percent and 80 percent.
Americans agree that inheritances should be taxed relatively heavily. According to one study, they support taxing wealth from inheritances at almost four times the tax rate on wealth from savings.
There are plenty of sensible options for increasing taxes on inheritances. Returning the estate tax to its 2009 levels would raise $270 billion over the next decade. Further increasing the rate so that it rises to 65 percent on estates over $1 billion would raise an additional $100 billion.
An even better approach would be to replace the estate tax with an inheritance tax. Under an inheritance tax, heirs would simply pay income and payroll taxes on their inheritance above a large exemption, just as others do on their wages.
If an inheritance tax exempted the first $1 million received over one’s lifetime and applied the highest income and payroll tax rates to amounts above that threshold, it would raise $790 billion over the next decade. Representative Jan Schakowsky, Democrat of Illinois, is drafting a proposal along these lines, and some former presidential candidates including Julián Castro endorsed the idea. Under this type of plan, only 0.08 percent of households would owe the tax each year. The revenue could be used to invest in children who aren’t lucky enough to inherit millions, whether through universal pre-K, paid parental leave or a fully refundable child tax credit.
Regardless of whether we shift to an inheritance tax, we should tax accrued gains on large bequests. This would raise $450 billion when combined with other reforms. And we should reverse the deep cuts to the I.R.S. enforcement budget, which have resulted in a 61 percent decline in audits of millionaires since 2010.
Finally, we should reform the rules governing transfers through trusts and similar devices, which the wealthy exploit to slash their tax liability. In one strategy, people put easy-to-sell assets into a partnership to artificially deflate the assets’ value. According to the nonpartisan Joint Committee on Taxation, these and similar strategies can reduce the value of transferred assets by 15 percent to 60 percent or more. The casino magnate Sheldon Adelson used a different strategy involving trusts to avoid $2.8 billion in estate and gift taxes between 2010 and 2013.
Others create trusts to benefit their descendants for centuries. The beneficiaries of such dynastic trusts should have to pay tax on their inheritances. While the total tax revenue at stake is unclear, trusts most likely hold trillions of dollars in assets.
President Franklin Roosevelt said “inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our government.” The same is true today.
We know how to tax inheritances more fairly. We need to act before the massive wealth transfers on the horizon further entrench a hereditary economic elite.
Ms. Batchelder is a professor at N.Y.U. School of Law and served as deputy director of the White House National Economic Council and deputy assistant to President Barack Obama.
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