Three Wrongs Don’t Make a Right: Thaler on Estate Taxes
7th November 2010
David Friedman is always worth reading.
What are the three errors, seen from the standpoint of measuring and taxing the real gains from buying and selling assets?
1. The failure to index capital gains, to measure them in real rather than in nominal terms. At a zero inflation rate this wouldn’t matter, but if inflation is substantial it taxes investors on imaginary profits, heavily discouraging any form of investment activity that will eventually show up on a schedule D.
2. The failure to retain the basis for capital gains when an asset is inherited. Under current law, when my imaginary investor dies in 1998 and his son inherits his $300 asset, the basis for the asset shifts up, so neither the real $100 gain nor the imaginary $100 gain ever pays capital gains tax.
3. The estate tax. Instead of paying capital gains tax on either the real or the imaginary capital gains, the son is taxed on the amount of the estate, some unknown fraction of which consists of actual capital gains. This is double taxation on part of the estate, single taxation on another part, and, given the exemptions in the estate tax law, zero taxation on a third part.