I’m not the least bit surprised that there are economic theories that specifically address estate taxation. But I was not the least bit aware of them until I read the recent NBER paper by Wojciech Kopczuk that “provides a non-technical overview of the economic arguments related to the desirability of transfer taxation and a summary of empirical evidence surrounding these issues.” (All quotations © 2010 by Wojciech Kopczuk.)
Kopczuk begins with a review and commentary of the literature on the bequest motive. He notes that altruism cannot fully explain inter-generational transfers as tests of that hypothesis are generally rejected.
It should also be pointed out that from the point of view of the optimal policy, altruistic preferences introduce a reason to subsidize rather than tax transfers and hence do not provide an argument for estate taxation that is observed in practice.
Continuing, Kopczuk finds that strategic or exchange-based motivations are also not compelling. Moreover, they do not suggest whether taxation or subsidization is, in general, appropriate. Is the child under-compensated or is the parent over-paying for whatever services are offered in the exchange?
The joy-of-giving perspective in which the donor does not internalize the benefits to the donee has been a “useful way of describing behavior and is often used in practice as a positive model of bequests,” Kopczuk writes. But it argues for subsidizing, not taxing, bequests in order to internalize their positive externality. He concludes that “while it may be a useful way of describing behavior, paradoxical implications of this theory highlight that it is not an appealing approach for thinking about welfare.”
Kopczuk also reviews theories based on the notions of accidental bequests (that the donor over-saved for other purposes, like retirement), wealth accumulation (that the building of family wealth is desirable for its own sake), and that bequests are a function of psychological biases or mistakes. His review of bequest motive theories concludes with the idea that likely more than one motive exists. This heterogeneity makes for difficult ground upon which to obtain a rational policy stance.
The paper pivots on a passage in which Kopczuk rejects a welfare-based approach to estate taxation. Instead, he finds the revenue implications to be paramount.
Yet, as discussed above, interpersonal externalities … call for subsidizing rather than taxing gifts. … Subsidizing gifts may well make sense for much of the public but this kind of externality should go away when we get to the top of the distribution: the marginal utility of income (or wealth) of both parents and children is low and hence the relevance of correcting bequest externalities is negligible. … [T]he precise nature of a bequest motive is relevant only in so far as its welfare implications are relevant and at the top of the distribution they are not. What is relevant are revenue implications of taxing bequests, but this is an empirical question rather than theoretical one.
Kopczuk then argues that estate taxation has different effects than income taxation because individuals may differ with respect to wealth and income for different reasons. That is, differences in income largely reflect differences in ability to earn wages. Differences in wealth, on the other hand, may reflect heterogeneity in other dimensions, like entrepreneurial skill or even luck. Thus an estate tax exerts different distortionary pressures than income tax. It is not a redundant mode of taxation.
What, then, justifies estate (or, for that matter, income) taxation? Kopczuk attempts to address this question by suggesting there are negative externalities of wealth concentration. He points to three negative externality candidates: (1) Some of the worst governed countries are also home to the highest concentrations of wealth; (2) Excess wealth can permit some individuals to dominate the state, potentially threatening democracy; (3) Retaining family control of a business prevents others possibly better equipped to run it from doing so. However, he admits that, “[d]etermining whether such externalities exist is an ongoing research issue.”
Finally, Kopczuk discusses what is known about the effects of estate taxation.
[I]t appears likely that both wealth accumulation and avoidance are responsive to tax considerations with neither of these effects being very large, but the bulk of response working along avoidance margin. … If indeed wealth accumulation is not too responsive to tax incentives, then arguments related to undesirability of capital taxation do not apply in this context.
In conclusion, Kopczuk has certainly provided an accessible review of estate tax economics, though I cannot judge its accuracy or thoroughness. In general, he is either not impressed with the literature (e.g., he finds welfare economics and the bequest motive irrelevant) or finds it insufficient (e.g., not enough is known about externalities).
It seems to me one cannot reason about estate taxation without simultaneously reasoning about income taxation, or other forms (like value added taxation). As Kopczuk pointed out, the taxation modes are different. For a constant level of desired government revenue, if one advocates more or less of one mode of taxation, it necessarily means commensurately less or more of another. Therefore, an argument about one can’t be sustained without knowing a considerable amount about the other, which I do not. (Educated readers, feel free to suggest papers.)