Frederich Hayek famously said “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” Professor Mario Muzzi, economics professor and department chair at the University of San Francisco, recites this quote from memory. In other words, his message is that the intended outcome will often fail to come through as intended. Hayek’s lesson has guided Professor Muzzi’s method of evaluating government action by measuring the gap between the intentions of policies and their actual outcomes. This approach is especially poignant when discussing redistributive taxes, particularly the inheritance and corporate tax. Despite these two taxes having at large the same goals, there is an inherent irony in supporting increases of both taxes, shielded by the buzz around the corporate tax and the lack of discussion on state inheritance taxes. In fact, Professor Muzzi questions whether the purpose of these taxes matches the moviations behind those advocating for increasing both taxes. Instead, he argues that between the corporate and inheritance tax, redistrbutive goals are better met with the inheritance tax because there are less distortive incentive effects that are more closely aligned with the tax’s goals.
An inheritance tax collects revenue on items bequeathed to heirs. It is often discussed in relation to the gift tax but is not the same as the estate tax, which is a tax on the value of the property. The inheritance tax operates at the state level and only 6 states collect it: Nebraska, Iowa, Kentucky, Maryland, New Jersey and Pennlsyvania. The tax rate ranges from 0 percent to 18 percent, depending on the size of the inheritance and the inheritor’s relationship to the bequeather. Broadly speaking, this tax has been used to address the fact that roughly 40 percent of all household wealth stems from inheritances.
Biden has proposed an exemption amount of $1 million, the 2009 level, where anything above that amount could be taxed as high as 45 percent. According to a proposal by the Urban-Brookings Tax Policy Center, repealing the gift and estate tax and imposing a cut-off for inheritance at $1 million with a minimum rate of 40 percent on excess of that amount, the tax would generate $484.5 billion over the next ten years. In comparison, from 2021-2030 (the same time frame), the Tax Policy Center predicts that the federal estate tax will generate $225 billion.
In contrast, the corporate tax rate is a federal tax on corporate profits. In order to pay for Biden’s infrastructure plan, his administration is particularly keen on increasing the corporate tax rate from 21 percent to 28 percent, compared to 35 percent before the 2017 tax cuts under President Trump, with some latitude for changes in hopes of reaching bipartisan support. In the period between 2021-2030, it is estimated that Biden’s proposed corporate tax hike will generate an additional $730 billion.
This is good news for most Americans who support both taxing large businesses and inheritances: Around 52 percent of Americans are in favor of raising the tax rate on corporations and big business, whereas 24 percent are in favor of lowering it, and 21 percent in favor of keeping it the same. 43 percent of Americans want wealthier households to pay more, whereas again 24 percent want these individuals to pay less and 29 percent want it to stay the same. More relevant, Americans support taxing wealth from inheritance at almost four times the tax rate on wealth from savings.
However, Hayek’s lesson on how little we know about what we hope and expect to produce appears to be somewhat lost on supporters of wealth redistribution who favor increases of both corporate and inheritance taxes. Professor Muzzi, on the other hand, has taken this lesson to heart. He favors the inheritance tax because it has a far more direct relationship to transferring wealth from rich to poor than the corporate tax rate. Put differently, the intended goals of the inheritance tax are more connected to the actual outcome than with the corporate tax rate.
To prove his point, Professor Muzzi starts with a few questions that are often neglected by those in support of increasing both taxes: “The question is who is the master you are serving? Is it equality? Is it growth? Is it also financing government services and maximizing government revenues? Is it some inherent other fairness issue?” Equality, fairness, growth, meritocracy, utility, and efficiency are a few of many values that drive America’s view of the purpose and effectiveness of these taxes. But are they achieved under either tax?
Americans who hold a myriad of values can justify supporting the inheritance tax; yet, there is still uncertainty in considering such a tax. At first glance, it appears that taxing inheritence is not good for the economy. The Urban-Brookings Tax Policy Center found that those recieving an inheritence were more likely to own or manage a business. Put simply, inheritance taxes hurt business. Yet, as explained by the Carnegie-Conjecture, named after leading philanthropist Andrew Carnegie, the greater the inhertience the greater the decrease in labor force participation, thus harming productivity and employment. In sum, taxing inheritance is conducive to increasing employment. Moreso, most studies find that any negative impact of the inheritance tax is small and only affects a few, older and wealthy people. Negative growth effects can also be minimized. In terms of economic well-being overall, the inheritance tax provides ample state revenue without disrupting the economy.
From the utilitarian perspective Muzzi argued that “If you leave your children 5 million dollars, that’s a pretty good head start in life. What’s the increased utility of leaving them another 5 million or leaving them 50 million?” The same line of thinking can be applied when considering fairness: there is a wide disparity between those receiving that much cash, the high end of the 1 percent making way over roughly $500,000, and the median household making $42,409, as of 2020. In both cases, the inheritance tax addresses these concerns.
Through the lens of efficiency, the inheritance tax creates a far more direct transfer of wealth from rich to poor, even if you adjust for money perceived as being wasted or money directed to certain special interests. “I know that two-thirds of the budget goes to social security and Medicare [and] a large portion of the people that receive social security and medicare are not rich,” Professor Muzzi explained. Although the figure is closer to 50 percent of the budget, excluding the 8 percent that goes to other safety net programs, the point stands. Taxes on the rich are mostly directed by the government to aiding the majority of Americans, many of which are less fortunate.
The main dissenters to this tax include wealthy and corporate interests. Although not a strong objection philosophically, the inheritance tax is disliked among those who value giving wealth to family. Further, it is contended that high-earners already face high taxes through income and capital gains taxes.
Although in a society where we acknowledge the need for redistribution, the inheritance tax can be viewed uniquely in that it takes effect after death. Although bleak, the fact is that this tax only affects those with wealth above a very high threshold, after death, and provides to those who are less well-off. Regardless of its redistributive success, it can be seen as the lesser evil.
Do these same justifications for an inheritance tax work with the corporate tax rate? Do Americans have a reason to be even slightly more in favor of taxing corporations than inheritances?
The brunt of the argument in favor of raising the corporate tax rate rests on fairness. “We need to get these fat cats to pay for their share,” Professor Muzzi stated. But are these “fat cats” really able to correct for fairness, among other things?
According to the Tax Policy Center, the Congressional Budget Office and the Congressional Joint Committee on Taxation, shareholders and capital bear roughly 80 percent of the effects of the corporate tax while labor bears 20 percent; however, these estimates are debated. Thus, in theory, the tax is effectively redistributive because it largely targets the top 1 percent of shareholders holding 57 percent of U.S. stock (the “fat cats”) to better adjust for the 90 percent of Americans owning only 12 percent of U.S. stock.
The counterargument to this process is laid out by the American Enterprise Institute; this think tank describes the “standard theory” accepted largely by economists across the spectrum and yet still disputed. The theory is as follows: with lower taxes, corporations will make more investments because they will pay less on these investments over time and thus will be more profitable; more technology and capital will build workers capacity to produce more output; with more output, more workers will be needed to continue production which increases hiring and bids up the price of wages as corporations compete for workers.
Nobel Laureate economist Paul Krugman’s response to this is: “there’s probably something to this theory — something, but not very much.” His reaction is, in part, a call to account for the theory’s assumptions: investments will be continually made, new capital and technology will improve workers productivity, and workers will advocate for higher wages. Debate on this theory rests on these stringent assumptions; mostly that the time period of the effect of corporate tax cuts on wages and investment growth is longer than expected. Put simply, it lacks efficiency and practicality. In Krugman’s words, “[this] story relies on a long chain of events with multiple weak links.”
Additionally, many economists argue that instead labor bears the greater burden and disagree on the magnitude of the effects. Meaning, as an utilitarian would see it, there is no clear majority benefiting. In fact, a study by the National Bureau of Economic Research from 1970-2010 found that increasing corporate tax rates lead to significant reductions in employment and wage income and that corporate tax cuts only boost the economy during recessions. Professor Muzzi in agreement with these studies reasons further, saying, “If a corporation has their taxes go up…there’s a strong change it will have some effect on the prices that the corporations charge for their services or products.” Considering that consumption of goods and services affects all Americans, utilitarian goals would not be achieved.
Muzzi reiterates: “The corporate tax is not really an efficient way to redistribute wealth,” because of these questions: “Who’s actually carrying that burden. Is it the consumers, is it the shareholders, or the workers of the corporation, or potential future workers of that corporation…” Further, he adds “Where are you going to point to me, successfully, where corporate tax rates have gone up and the Gini coefficient [a measure of economic inequality] has gone down.”
Inequality aside, according to an OECD review in 2010, in congruence with the standard theory, the corporate tax’s effect on investment and savings harms economic growth in the long-run.
Unlike with the inheritance tax, the ability of the corporate tax rate to achieve equality, fairness, utility and growth ‒ among other things ‒ is unproven. It appears that this tax brings more harm than good and doesn’t address such societal values altogether.
The most striking difference between these two taxes has to do with the incentives. As Muzzi purposes, supporting a tax should have to do more with assessing the incentives created by such a tax ‒ that is, the effects on behavior. He explains, saying, “If we are going to do any redistribution… the moment of death is when I would do it because I’m worried about the incentive effects when people are alive.”
Muzzi uses Google as an example to further explain the importance of incentives. “I don’t want a society that takes from [Google] because then I’m worried about the incentive effects in the future. Whereas when they die, then I kinda like the idea of a society that then redistributes at that point in the hopes of creating a level playing field for the next Sergey Brin and Larry Page.”
For Muzzi, the inheritance tax is broad-based enough in that there are fewer avenues for people to use loopholes than those with the corporate tax and thus fewer distortive incentive effects. Muzzi claims, “[With] the corporate tax I can give you 100 different examples of how his [the corporation’s] behavior will change…you know he’s going to try to avoid that tax during his lifetime or minimize it and so it has really distortive effects.” Considering the incentivizes created by these taxes, the inheritance tax appears again to be the winner.
Assessing the value-based justifications for inheritance and corporate taxes, opens a whole other set of inquiry into whether taxes, as opposed to other policies, should be expected or intended to address issues of inequality, fairness or to achieve any other value we share as Americans.
Muzzi has his own take: “You might have all these grandiose ideas about how to make the world a more fair and just place…one of those ideas is we wanna avoid cronyism, we wanna avoid aristocracy, we want things based on merit, we want a level playing field, we want children of all social economic beginnings to have a fair opportunity to climb that ladder…But… if you try to use the tax system for that, I think history has shown it hasn’t really done a good job.”
As Hayek cautioned, our economic landscape shows us that our expectations of such policies, like with taxes, often fall short of reality. Americans can build their views of taxes around their values but must examine if and how their values are truly reflected in these policies.
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