Tax inheritance more to reduce income tax?

Last May, inher­i­tance tax was put under the eco­nom­ic spot­light when the OECD pub­lished a report in favour of increas­ing the use of inher­i­tance tax­es to “strength­en equal­i­ty of oppor­tu­ni­ty and reduce wealth inequal­i­ty”¹. To ensure greater social jus­tice, the report pro­posed that inher­i­tance should no longer be taxed at the lev­el of the giv­er. Instead, it should be paid based on the receiv­er. Before look­ing at pos­si­ble reforms, let’s look at this tax a lit­tle clos­er to under­stand its complexity.

Sta­tis­tics show that 87% of French peo­ple con­sid­er that it is nec­es­sary to reduce inher­i­tance tax – almost 10% more than a few years ago²³⁴⁵. What is aston­ish­ing is not only that this reluc­tance accom­pa­nies the increase in the share of inher­it­ed wealth in our soci­eties but also that this tax is unpop­u­lar even among those who do not pay it. It is cer­tain­ly legit­i­mate to want to pass on all or part of one’s wealth and to fear not being able to do so. But, in the end, few peo­ple pass on large amounts and inequal­i­ties are high: the small­est 50% of trans­mis­sions rep­re­sent less than 5% of the total, while the largest 10% rep­re­sent as much as half – which is close to the inequal­i­ties in wealth. More­over, the cur­rent sys­tem means that most trans­fers are not even taxed, which rais­es ques­tions why so many peo­ple who will nev­er even have to pay this tax reject it. There are sev­er­al rea­sons for this sur­pris­ing unpopularity.

First, inher­i­tance tax is very com­plex. There are dif­fer­ent types of allowances that vary accord­ing to the rela­tion­ship (chil­dren are taxed less than grand­chil­dren, who are taxed less than broth­ers and sis­ters, etc.), a non-repay­ment peri­od, and a tax rate that varies accord­ing to the num­ber of chil­dren), a non-recall peri­od for dona­tions (those made more than 15 years before the death or before anoth­er dona­tion are no longer tak­en into account) as well as spe­cial regimes for busi­ness assets and life insur­ance (where, as an addi­tion­al com­plex­i­ty, tax­a­tion also depends on the age of the hold­er at the time the funds are paid out) and even for cer­tain finan­cial ‘gifts’. Like any com­plex sys­tem, it is poor­ly under­stood. Sur­vey after sur­vey, tax­pay­ers report a pro­found lack of knowl­edge about this tax: with a strong ten­den­cy to under­es­ti­mate deduc­tions and over­es­ti­mate the tax actu­al­ly paid.

In France, for exam­ple, each par­ent can give €100,000 net to each of their chil­dren every 15 years. For a cou­ple with two chil­dren, this rep­re­sents over €400,000, which is more than the gross wealth of 8 out of 10 French peo­ple, accord­ing to INSEE. This lack of knowl­edge is not unique to the French and sev­er­al recent stud­ies have high­light­ed the role it plays in rejec­tion of inher­i­tance tax else­where – show­ing that avail­abil­i­ty of infor­ma­tion clear­ly increas­es sup­port for this type of tax­a­tion. In Swe­den, for exam­ple, where peo­ple receive more infor­ma­tion about the share of inher­it­ed wealth in soci­ety are more like­ly to sup­port inher­i­tance tax⁶. This is also the case when peo­ple are remind­ed of the con­crete con­di­tions for being taxed and the share of peo­ple affect­ed by the tax, as has been shown in the US⁷. This infor­ma­tion is there­fore an impor­tant and nec­es­sary ele­ment in any debate on the issue.

It is also worth men­tion­ing the under­ly­ing feel­ing that this tax is unfair. A rea­son for this is that about half of the amount col­lect­ed is levied on so-called “indi­rect line“ trans­fers, i.e. trans­fers not between par­ents and chil­dren – even though these trans­fers only rep­re­sent about 10% of the amounts trans­mit­ted. This is because they are more high­ly taxed than the oth­ers. For exam­ple, the allowance for nieces and nephews is €7,967 com­pared to €100,000 for chil­dren. The tax rates are also much high­er, start­ing at 35% for sib­lings, 55% for nieces and nephews com­pared to 5% for chil­dren. This gives the impres­sion that peo­ple with­out chil­dren are less legit­i­mate in want­i­ng to pass on their wealth than oth­ers. In con­crete terms, if a per­son pass­es on €100,000 to his or her daugh­ter, there will be no tax to pay, where­as it will be over €50,000 if the same amount is passed on to a niece. In these cir­cum­stances, the tax rate, and the amount of tax paid depend more on the rela­tion­ship than on the amount passed on.

The OECD’s pro­pos­al to tax trans­fers not at the lev­el of the per­son pass­ing on but at the lev­el of the per­son receiv­ing is an inter­est­ing idea, already put for­ward by oth­er insti­tu­tions. These include France Stratégie and aca­d­e­mics such as Antho­ny Atkin­son⁸ or the Nobel Prize win­ner James Meade⁹. Last June, the com­mis­sion head­ed by econ­o­mists Olivi­er Blan­chard and Jean Tirole also rec­om­mend­ed the use of this tax, tak­ing hold of the idea¹⁰. 

Empir­i­cal stud­ies are few but sug­gest that inher­i­tance tax is less dis­tort­ing than oth­er types of tax­es and that the fear of a tax exo­dus of old­er peo­ple seems unfound­ed^{11121314151617}. The ben­e­fits thus seem to out­weigh the poten­tial loss­es. This tax­a­tion even seems to have pos­i­tive effects on the labour sup­ply of heirs and to pre­vent busi­ness­es from being passed on too often to unskilled heirs¹⁸¹⁹. These con­sid­er­a­tions also make it pos­si­ble to change the way in which the debate could be positioned.

Rather than ques­tion­ing the appro­pri­ate­ness of increas­ing a tax in a coun­try where com­pul­so­ry deduc­tions rep­re­sent a sig­nif­i­cant part of the income of the vast major­i­ty of the pop­u­la­tion, we could ask our­selves how to design a more effi­cient and pro­gres­sive sys­tem. For exam­ple, would it not be appro­pri­ate to reduce the tax­a­tion of earned income by redesign­ing and mak­ing the trans­fer tax more pro­gres­sive? The tax base is clear­ly not the same and bet­ter access to tax data on dona­tions and suc­ces­sions would be need­ed to quan­ti­fy this issue in more detail. But high­light­ing this trade-off would make it pos­si­ble to debate more clear­ly a choice between, on the one hand, tax­ing work, an activ­i­ty that con­cerns the vast major­i­ty of cit­i­zens, and on the oth­er hand, tax­ing the high assets trans­mit­ted, which con­cern a much small­er pop­u­la­tion that is old­er and wealth­i­er overall.