State of the play academically on wealth transfer taxation

Yesterday I went to a session at Columbia Law School where my colleague, Lily Batchelder, was presenting her paper, "How Should an Ideal Consumption Tax or Income Tax Treat Wealth Transfers?" Lily is doing excellent and important work in this area, ranging from her actual policy proposal as part of the Hamilton Project to the more theoretical inquiries she is pursuing now. But even apart from any one individual's distinctive view of the area, I think it's important to say something about the current state of the play, which Lily helps make her clear both through her own contributions and through the prior empirical literature she cites.

Ten years ago, I would have said the jury is out in the academic and tax policy literature, so far as the merits of wealth transfer taxation are concerned. E.g., there is no particular reason one should favor wealth transfer taxation just because it's progressive, given that in principle equal progressivity could be obtained with or without it, through adjustments to other tax instruments.

From a 2007 perspective, however, I think the case for wealth transfer taxation has pretty much been made. A key point that Lily's work makes clear is that inheritance taxation - where the tax depends on the circumstances of the recipient - is theoretically superior on informational grounds both to estate taxation - where it depends on the size of the bequest - and to no tax at all on wealth transfers. The inheritance tax option uses more distributionally relevant information than do the other mechanisms. E.g., my wellbeing clearly depends on the wealth transfers I receive, plus other stuff I have or can earn, so the tax system is depriving itself of distributionally relevant information if it ignores the wealth transfers or fails to interact them with what else I have.

Now for a refinement, potentially reversing the seeming import of what I just said. The clear superiority, on informational grounds, of inheritance taxation over the alternatives does not tell us that the inheritance tax rate should be positive. This depends on a whole raft of relevant inputs, including (as Lily's work makes clear) the case for subsidizing gratuitous transfers due to the "altruistic externality" that Louis Kaplow may have been the first to emphasize. So to say we should have an inheritance tax isn't to say we should burden inheritance relative to not having a wealth transfer tax - just that in theory it ought to be taken into account somehow, which straight exemption fails to do.

But here is what I would argue is the clincher in terms of a positive inheritance tax rate (again, recognizing that there are complicated multiple inputs). Recent empirical research concerning bequest motives and practices, including, e.g., work by Wojciech Kopszuk of Columbia University, suggests that "accidental bequests" (those reflecting imperfect lifecycle saving and annuitization rather than bequest motives) are a sufficiently large piece of the whole to suggest that the distortionary effects of taxing wealth transfers, e.g., the discouragement of work and saving by future decedents (which we all are), are likely to be substantially lower than they would be if bequest motives were doing more of the work. So there are likely to be substantial efficiency advantages to this device for taxing work and saving, relative to the use of standard annual income or consumption taxation.

All this is not just high theory, of course. The estate tax is actually scheduled to disappear in 2010 and then re-appear in its pre-2001 form in 2011. This is a crazy and implausible sequence of rule changes, leaving aside the fascinating "throw momma from the train" research opportunities that it would offer empirically minded economists. So something is bound to be done. It thus is well worth knowing how strong the academic case for some type of wealth transfer taxation, especially an inheritance tax, now appears to be.

I myself would combine inheritance taxation in some form with a progressive consumption tax in lieu of the current income tax, but this is a topic for another day (actually for a past not a future day as I have written about income and consumption taxation quite a lot in recent years).