Thursday, 11 November 2010

Steve Landsburg's fallacy re. Estate taxes (Death duties)

Landsburg just won't quit with his double-tax fallacy.
This is from his blog of a couple of days ago.
Dick Thaler, writing in the New York Times, says so many wrong things about the estate tax that I don’t know where to begin. But let’s begin here:
First, it is incorrect to say the estate tax amounts to double taxation. The wealth in many large estates has never been taxed because it is largely in the form of unrealized — therefore untaxed — capital gains.
This is just not true. Virtually all of the wealth in every large estate has already been taxed at least once. Namely, it was taxed when it was earned. You do not understand this issue unless you understand the following simple example: Scrooge McDuck earns a dollar, makes some fortunate investments, and leaves a hundred million dollars in unrealized capital gains to his ne’er-do-well nephews. If Scrooge has to pay 50 cents income tax on that dollar, then he invests half as much, earns half as much, and leaves his nephews half as much. Scrooge’s fifty cent tax bill has already cost his nephews fifty million dollars.

In fact, there’s a good chance Scrooge (or his ancestors) earned a lot of that money back in the bad old pre-Kennedy days when marginal tax rates hovered around 93%. If so, 93% of the estate is already lost to taxes. That’s pretty far from nothing.
A more accurate statement might be this:
First, it is incorrect to say the estate tax amounts to triple taxation. The wealth in many large estates has been taxed only once because it is largely in the form of unrealized capital gains. Therefore the estate tax amounts to double taxation, not triple.
Of course, when you say it the more accurate way, it stops looking like an argument for estate taxation.

Why is this silly? Well, in an economy with no market failures (situations where markets screw things up) one might want all economic activities to be taxed at the same marginal rate.  In the old days people said- ah money earned by the sweat of one's brow should be taxed less than money from rents or savings. The problem is if you penalize savings or rental incomes then an important type of economic activity will be under-provided and in the long run everybody suffers.

Landsburg, of course, is on the side of the rich and wants money earned from rent, interest or profits not to be taxed at all- because this is 'double taxation.'
Let us take an extreme case to support his view. Granny Sweetums is a widow who earned $1 by scrubbing the floor of  Tax Inspector  Nasty. He promptly taxed her income at 50% leaving her with 50 cents. Granny Sweetums did not spend the 50 cents because she planned to buy her grand-daughter Goldilocks a nice new pair of titties for her 21st birthday. However, instead of giving the money to Goldilocks or pre-paying the plastic surgeon, Granny Sweetums hid the 50 cents in her panties (where not even Tax Inspector Nasty would look for it). Goldilocks would often say to Granny Sweetums, 'Kindly hand over the cash you dumb broad. Don't you know that Death Duty is levied at 50%?"
Granny Sweetums replied 'I would if I could be sure I'd be dead by the time you are 21 and thus legally entitled to work as a porn star. What if I live beyond that time whereas you are run over by a bus? That's why I'm hanging on to the 50 cents.'

Sadly just before Goldilocks 21st birthday, Granny Sweetums keeled over and died. The undertaker found the 50 cents in her panties and Tax Inspector Nasty immediately took 25 cents in inheritance tax leaving Goldilocks with money for only one boob enlargement- thus confining her to the unprofitable early Victorian silhouette end of the Porn industry where she met Steve Landsburg. Being a chivalrous sort of fellow he challenged Tax Inspector Nasty to an internet debate.
"You are guilty of double taxation!" he thundered angrily.
"Not so." said Nasty, "I am taxing an economic good or service which did not previously exist, Granny Sweetum's death created a hedge against the uncertainty and need to maintain a precautionary balance which her previously unknown date of death was responsible for. In other words, something- namely a hedge- has been created for the Estate and it is that which is being taxed. Had Granny bought a hedge in the market that would have been taxed. It is the implicit hedge which has fructified which I now lay claim to. The situation is the same as that of a unrealized and previously un-monetized capital gain on an asset which becomes so when it comes under probate. The moment something enters the market, or is exchanged, an economic activity occurs. The canon of neutrality requires it be taxed at the same rate as any other economic activity. This is different from a simple transfer. Had Granny Sweetums pre-paid the plastic surgeon for the boob-job no tax would have arisen other than the one she paid as Income Tax. By keeping the 50 cents in her knickers Granny was using the money to buy something for herself- viz. a hedge against the uncertainty arising from her unknown date of death. Her death relieved her Estate of that cost which we are taxing as though it had been paid through the market because under the law of probate this money now comes to Goldilocks not as a voluntary gift or transfer but as something on which she has a legal and enforceable claim upon.
'Goldilocks could not have sued Granny for the 50 cents since she had no legal claim to it. However, under the law of probate, Goldi does now have a claim to the residue of the Estate after tax. This  is an exchange, not a transfer, and since it is an economic exchange based on a new state of the world- viz. the reduction in uncertainty concerning Granny's date of death- a good or service has been produced, is measurable, and can be easily taxed-ergo it should be taxed."

But Steve Landsburg wasn't listening. He just repeated the argument all over again on his blog a couple of weeks later.
Goldilocks is doing well as a shadow puppet in Thailand.
Tax Inspector Nasty was fired for racially abusing a typist of Indian origin and sexually harassing a Japanese photocopier. He now writes children's books under the pseudonym Arianna Huffington Bear.


Anonymous said...

I suppose being a legacy hunter is an economic activity. Instead of providing services for elderly people which they pay you for, you could go in for cozying up to them so as to get a legacy.
Let both activities be taxed at the same rate by all means.
Daddy giving kiddy money is one thing. But daddy saying wait for it till I'm dead and make sure you don't piss me off- is a daddy who is making sonny boy work for his legacy. Work is work. Tax it by all means.

shiela said...

I looked at Landsburg's post and it got me thinking. You mustn't tax savings because it was already taxed when received as income. You mustn't tax capital gains because the asset was bought with income which had paid already paid tax. You mustn't tax Estates on death because all the money in it ultimately derived from income which was subject to tax.
It follows you mustn't tax Consumption either because its just a case of negative capital gain- who is to say you did not buy that tomato with a view to seeing it appreciate in value, or hoping to hand it down as a beloved heirloom to your descendants? All property in the country should be vested in the old comatose guy most likely to die in the next week subject to his heir being the next most likely to die. All monetary transactions should be re-classified as transfers within the old guy's estate. Result? There is nothing to tax! Yes there's people working in factories and offices and so on- but who is to say they aren't just volunteers trying to please the old man in the hope of receiving a gift?
The point about taxing income from an economic activity at the same marginal rate is that it should remove the incentive to go in for this sort of subterfuge.