There’s another way to tackle the problem. Instead of focusing only on taxing wealth accumulation, we can address the hidden flip side — wealth transmission. America’s super-rich have created a little-known parallel legal system in some unlikely states. There, they pass on massive amounts of wealth tax-free and lock in inequality for generations, exploiting cracks in our system of taxing inherited wealth.
The first step to reining in this system is to recognize its existence. The place to start is South Dakota, which has quietly made itself the world’s leading money haven, crushing former go-to shelters such as Switzerland and the Cayman Islands.
In theory, the super-wealthy pay some taxes when they pass on estates beyond the current tax-free exemption level of $11.7 million for an individual, $23.4 million per couple. But the reality is that the wealthy find legal ways to shelter their enormous estates using tax avoidance tools that understate their assets’ true values. Often, they avoid any state or federal taxation whatsoever.
Only about 1,900 of the roughly 3.1 million people who died in 2020 will pay federal estate taxes. In total, these estates will pay perhaps $16 billion — roughly a 2 percent average tax rate on America’s inherited income, one-seventh the average tax rate on income from work and savings.
How is this possible?
Enter South Dakota. The state has created a bespoke legal system for America’s richest families, with wealth-sheltering tools including the aptly named “dynasty trust.” In 1983, the state adopted a 19-word law that effectively abolished the “rule against perpetuities,” an ancient, obscure rule that had one salutary effect: It kept families from locking up wealth perpetually. After the repeal, wealth advisers began advertising South Dakota as the go-to solution for aristocrat wannabes.
Nevada, Alaska, Delaware and other states also participate in this race to the bottom. South Dakota fends off competition with annual legislative giveaways: new “asset protection” and “decanting” tools for rejiggering existing trusts to stiff spouses, children, business partners and accident victims — while making wealth transfer taxes optional and ensuring ever-stricter secrecy.
The giveaways work. Hundreds of billions in free-floating wealth have drained into the state. “To some, South Dakota is a ‘fly-over’ state,” boasted South Dakota Supreme Court Chief Justice David Gilbertson in a 2019 address to the state legislature. “While many people may find a way to ‘fly over’ South Dakota, somehow their dollars find a way to land here.”
This sounds almost gleeful, but who benefits in South Dakota? Only the family wealth advisers who propose the rules. The trusts pay no state income, capital gains or inheritance taxes in South Dakota. Almost no roads get built, no schools funded. South Dakota gets no tourism or investment bump. The rich don’t even visit to sign papers.
America’s ultra-wealthy have pulled off a brilliantly designed heist, with a string of South Dakota governors as accomplices. Nearly no one in South Dakota complains, because the harm falls on the national economy, federal taxpayers and places such as New York and California where the super-rich actually live.
We all suffer high and hidden costs from this parallel legal system — paying more in taxes and getting less in government services. And by hyper-concentrating wealth, South Dakota locks away resources that could spark entrepreneurial innovation.
All this is possible because, in the United States, states mostly define family ownership, not the federal government. Effectively, South Dakota is setting national policy.
But Congress can override these choices and plug holes in our leaky estate tax system. One step would be to tax trusts at the passage of each generation and limit generation-skipping tax-exempt trusts. A bigger step would be to ensure that appreciated stocks — a big driver of wealth inequality — are taxed at least once. As a candidate, Joe Biden made that a centerpiece of his tax plan.
Better still, let’s start anew. Ditch the existing estate tax and replace it with an inheritance tax on those who receive the wealth. Answer the GOP’s bogus “death tax” claims with a “silver spoon tax” — such as that proposed by Lily Batchelder, Biden’s nominee to oversee federal tax policy — that reins in windfalls to kids of super-wealthy family dynasties. Heirs of inherited income should pay at least a fraction of the taxes the rest of us pay on income from work.
A country created in opposition to inherited status now has states competing with one another to promote perpetual family wealth. This is not a progressive position, but neither is it within any sensible version of American conservatism, a political tradition committed to individual freedom, opportunity and markets.
The pandemic windfall to the super-wealthy creates a rare opening: to unite left and right in common cause against the United States’ ascendant aristocrats.