In the 'death tax' debate, both sides are unconvincing

The estate tax is an issue on which I'm almost convinced I agree with my progressive friends (who ardently defend the tax) — right up until they start explaining their reasons for thinking it a wise public policy.

I then conclude that I must concur with conservatives, who badly want to kill the "death tax."

This agreement generally evaporates the moment my conservative friends start explaining why they favor estate tax repeal.

The seemingly immortal death tax debate is back in the news, of course, as a relatively minor element of the Republicans' massive tax overhaul legislation, which moved closer to enactment last week with passage of a Senate version.

The huge measure has some virtues and many problems, above all a ruinous cost that will deepen the nation's debt crisis.

But while the estate tax — which is sharply cut or entirely repealed in the bills moving toward conference committee in Congress — is only a subplot in this larger drama, the debate over it exposes so clearly the cloudy thinking about taxation in both of our ideological tribes that it's worth a few moments' focus.

The two sides offer some practical arguments for and against the estate tax, which is currently levied against inheritances above $11 million. Its enemies say the estate tax discourages work, investment and capital formation among those amassing fortunes, and so stunts economic growth. But disincentives of that kind accompany every tax.

And in fact one needn't be unusually cynical about human nature to suppose that, to the extent the estate tax is different in this respect from other taxes — say, the income tax — the levy on inheritances may actually discourage wealth creation less than other taxes for the simple reason that it is ultimately paid by someone else. Even if the someone else is one's beloved heirs.

Defenders of the estate tax, for their part, note that it raises considerable revenue. But again, any tax can do that. The question that properly dominates this debate is whether this particular sort of tax is just.

"Death tax" critics insist it is uniquely unjust to use a person's death to impose "double taxation" — yet another tax on wealth that was already taxed when it was earned.

There are two separate ways this popular argument makes little sense. The first is that, where inherited assets such as stocks and real estate are concerned, heirs quite commonly receive large amounts of wealth that has never been exposed to taxation even once. That's because tax law allows heirs to inherit assets at their value at the time of the benefactor's death. The capital gains that have accumulated are never taxed unless "realized" by the original owner.

So long as that provision of tax law remains unchanged, the estate tax is actually an important way to tax at least some investment income that would otherwise escape levies altogether.

Meanwhile, the notion that it is unjust for the "same income" to be taxed more than once arises not only in the debate over the estate tax, but in connection with other taxes as well. Critics of GOP plans to cut deductions for state and local taxes also decry the "double taxation" that would result.

The basic confusion here comes from thinking of "income" as a particular stack of dollars. In reality, "income" is an event — the transfer of resources from one person to another. So long as a given income event is not taxed differently than other income events, no discrimination results that could distort economic decisionmaking, even if more than one jurisdiction imposes a levy.

Meanwhile, when Mr. and Mrs. Rich accumulate their millions, that is one income event; when they bequeath those millions to the Rich kids, that is a separate income event. Taxing each event is not double taxation because they don't involve the same "income" in any meaningful sense.

But what of the danger that family farms and family businesses will be destroyed by estate tax liability?

The evidence suggests that very few farms and businesses are lost to estate taxes, given the large amount of wealth that can be transferred before the tax kicks in. And however that may be, as an ethical matter it's not clear why a family-owned ranch or hardware store should be sacrosanct in a way a family-owned stock portfolio is not.

But if the critics' case against the death tax is unconvincing, what of its champions' prime justification for this tax — the most common refrain of all heard in the estate tax debate?

We are soothingly assured at every turn that only an almost infinitesimal minority of super wealthy Americans pay estate tax — about two estates out of every 1,000. What could there possibly be to dislike about that?

It's disheartening that so many modern Americans can't answer that question, and seem to think it a virtue that the estate tax is starkly discriminatory. Nothing so strongly suggests that Americans, in truth, do not consider estate taxes fundamentally fair as this fact:

Government apparently dares not impose such taxes on more than a tiny, unpopular minority of heirs.

One of the elementary safeguards against oppression is the old rule-of-law principle embodied in the U.S. Constitution's call for "equal protection of the law." It's the principle that "majority rule" can safely be allowed only so long as members of that majority must themselves live under the laws they enact.

The idea is that people aren't in the habit of oppressing themselves — so general laws that apply to everyone will seldom be tyrannical.

But once allow a majority to impose special burdens on a minority, without bearing the same burdens itself, and injustice is imminent.

This idea, of course, is often overextended to argue against all progressive taxation — taxing the rich more, proportionately, than the poor. But in the case of progressive income taxes, a great many Americans, most of those with significant income, pay at least some tax.

With the estate levy we have a type of burden that the overwhelming majority of Americans impose on a minuscule few without exposing themselves to any dose of the same medicine.

This should give us pause, not comfort.

The real trouble with the estate tax may be that too few Americans pay it. If taxes on inheritances are just and wise, maybe some estate tax should be paid on every inheritance, however modest, probably through steeply progressive rates — just as nearly any substantial income produces some income tax liability.

If nothing else, this proposal might inspire Americans to think a bit more carefully about the whys and why nots of this tax.

D.J. Tice is at Doug.Tice@startribune.com.