THE REAGAN ADMINISTRATION'S proposal to halve federal inheritance taxes has sailed through Congress with hardly a murmur of dissent. Indeed, the House Democrats' "alternative" tax plan incorporated the administration's proposed cut without change. It is easy to see why rich Republicans want to lower inheritance taxes. It is harder to see why liberal Democrats, who only yesterday proclaimed their commitment to equality of opportunity as a basic American ideal, should now think the rich need help in passing along their wealth to their children.
Lower inheritance taxes will not benefit the average family, since estates of less than $175,000 are already exempt from federal tax. Such estates may seem like peanuts to those who are currently drafting our tax laws, but the great majority of Americans still leave far less. Nonetheless, the administration-backed law raises the exemption to $250,000 in 1982, $325,000 in 1983, $400,000 in 1984 and $600,000 in 1985. The administration estimates that by 1987 only 0.3 percent of all estates will be subject to federal taxes, and even these will pay far less tax than they do today. As a result, federal receipts from from the estate tax will fall in 1986 by $5.6 billion.
Even under existing rates, wealthy parents usually manage to ensure that their children are almost as wealthy as the parents were. A study of Connecticut probate records from 1931 to 1977, carried out by Paul Menchik of Michigan State University, found that if parents had a combined estate 10 times as large as the average for their generation, they could expect their children's estates to be eight times as large as the average for the children's generation.
Rich parents help their children accumulate wealth in a variety of ways, of which direct inheritance is only one. Long before their children have inherited any capital, for example, they have usually "inherited" a college degree, for which they have made far fewer sacrifices than most college graduates have to make.
Furthermore, even when men have the same IQ scores and attend the same colleges, research by William Sewell and Robert Hauser at the University of Wisconsin has shown that those with high-income parents end up in better paid jobs than those with low-income parents. Thus when the children of the wealthy finally inherit money, they seldom need it for current expenses. This makes it easy for them to accumulate capital rather than spend it.
Of all forms of privilege in America, wealth is by far the most dependent on having the right parents. If a man earns five times the national average, for example, he can only expect his sons to earn about twice the national average, whereas if he has an estate five times the national average he can expect his sons to have estates four times the national average. These figures do not suggest that america has managed to give children from all walks of life equal access to highly paid jobs, but they do suggest that we have come closer to this ideal than to the ideal of giving everyone an equal chance to accumulate substantial wealth. There are, of course, a lot of self-made millionaires and even billionaires in America. But there are more such people who owe their wealth to their parents.
While this situation obviously violates the ideal of equal opportunity, there is very little support for confiscatory inheritance taxes, which would be a minimal first step toward equalizing opportinities to accumulate wealth. While we all believe in equal opportunity, we believe even more strongly in the parents' right to do everything they can to help their children. When we say that our children should start life with the same opportunities as everyone else's children, we mean that our children should be no worse off than anyone else's children. We don't mean that society shoudl prevent us from giving our children every advantage we can. Since some of us can obviously give our children far more advantages than others, equal opportunity remains a mirage.
Nonetheless, our present system of inheritance taxes does not conform to anyone's ideals of social justice. One fundamental problem is that inheritance taxes vary according to the wealth of the deceased, not according to the wealth or income of the beneficiaries. If a woman with $150,000 dies and leaves it all to her favorite nephew, the nephew pays no federal taxes whatever on his windfall. But if she tries to divide $600,000 equally among four nephews, the federal government claims $145,000 before they can divide the estate. They therefore end up with $113,750 apiece instead of $150,000. Furthermore, if a millionaire inherits money, the tax is precisely the same as if the beneficiary were an invalid with no money at all.
Another problem is that even at present we tax inheritances at a far lower rate than earned income. If a family had earned $175,000 last year from salaries or self-employment, for example, it would have owed the federal government close to $75,000 in income taxes. it if had been the sole heir to an estate of $175,000, it would have owed nothing. If a family had earned $600,000, it would have paid almost $300,000 in taxes. If it had been sole heir to an estate of $600,000, the inheritance taxes would have been only $145,000.
Since the wealthy already succeed in passing on their wealth to their children in most cases, why does anyone think that inheritance taxes should be reduced? The rich, of course, almost always think all taxes should be reduced. But the rich are a tiny minority, so the case for lowering their taxes must always be couched in language that equates the interests of the rich with the welfare of society as a whole. The inheritance tax cut was sold on these grounds.
According to its proponents, the inheritance tax cut is not really a windfall for the rich but a last-ditch effort to prevent large corporations from taking over small family farms and businsses. Today's inheritance tax rates, according to Sen. Malcolm Wallop (R-Wyo.), are so high that when parents die their children are frequently forced to sell the family farm or business just to pay the taxes. By eliminating this burden, he argues, the federal government can help small enterprises survive the threat of corporate takeover.
This argument has several crucial flaws. While it is impossible to say precisely why any given set of heirs decides to sell a family farm or business, the most obvious reason is usually that they think they can make more money by selling out and investing the money elsewhere. This will remain true with or without inheritance taxes. Moreover, in cases where the inheritance tax does play a decisive role, ther are ways to solve the problem without giving a windfall to the rich.
Consider the economic lure of selling even without inheritance taxes. A family farm can easily be worth $1 million at today's prices. Selling such a farm and investing in government bonds will currently bring the heirs more than $100,000 a year in interest, and will also allow them to take (or keep) salaried jobs. If they keep the farm and manage it themselves, they are unlikely to make even half as much, and they will almost certainly have to work harder and worry more. Although the farm will appreciate in value with inflation, while government bonds will not, a lot of farmers' sons and daughters are unwilling to pass up shrot-term benefits for such problematic long-term gains.
Infation encourages children to sell family farmsand businesses for another reason as well. Parents mostly divide their estates equally among their children. In most cases, however, only one of the children wants to manage the family farm or business. The others often want thei share inc ash: to make a down payment on a house, to start their own business or simply to avoid financial entanglement with a brother or sister about whom they have mixed feelings. The son or daughter who wants to take over must usually buy the others out, and this usually means borrowing heavily. In periods of rapid inflation, lenders demand very high interest rates to compensate them for the reduced value of the dollars in which they are repaid.
The son or daughter who borrows money to buy out the other hairs can easily end up owing more interest than the business or farm currently produces. The value of the business will, of course, also increase with inflation, but the short-run cash flow problem often looks almost insoluble. Faced with these difficulties, heirs often decide to sell.
Inheritance taxes exacerbate the problems created by dividing estates among numerous heirs, since the federal government becomes, in effect, still another "heir" demanding cash. for a family with a $600,000 business and three children, for example, the federal government's demand for $145,000 is equivalent to having had a fourth child. Dividing the estate four ways instead of three obbiously exacertes cash flow-problems.
If the Reagan administration were concerned only with saving family farms and businesses, it would be quite easy to write special tax provisions to solve the cash-flow problems that inheritance taxes create. The Internal Revenue Service could, for example, defer payment of inheritance taxes on such assets, and tie payments to the annual income the assets generated.
But the talk about family farms and businesses is in fact little more than a fig-leaf covering the administration's real intent, which is to make life easier for the rich in general. Most of the people who benefit from reduced inheritance taxes will not be children of farmers or small businessmen, but children of successful doctors, lawyers, real estate developers, corporate executives and the like, whose estates consist of stocks, bonds, cash, residential homes and rental property, not family farms or businesses. It is hard to think of any reason why these people should pay less tax on money they inherit than on money they earn.
If we want an equitable inheritance tax, the first step is to stop taxing estates and start taxing those to whom the estates are left. One simple and effective approach would be to tax inheritances as ordinary income in the year they were received -- though recipients of large inheritances would, not doubt, choose to average their income over a longer period, just as they now do when they earn an unusually large amount in a single year.
No such reform is likely to pass Congress in the near future. Bit if congressmen who believe in equal opportunity are still looking for an "alternative" to "Reaganomics" next year, such an inheritance tax proposal would certainly be more consistent with their ideals, and probably have more appeal to their constituents, than the presidents notion that we should simply eliminate inheritance taxes on most estates.