Death taxes punish the living

Reintroducing inheritance taxes would be a backward step for Australia that falls short on both economic and ethical grounds.

A feature of the fiscal policy debate this year has been the unstinting efforts of numerous interest groups reframing the narrative about the nature of, and solutions to, Australia's immense budget problems.

Contradicting the bare facts of general government sector overspending, with current expenditures by all levels of government exceeding revenue collections by $24 billion last financial year, the pro-revenue lobbies claim our public sector is wasting away because of a "revenue deficiency".

Against the background of a federal government encouraging a free-for-all discussion about policy changes, proponents of a greater national tax take have recently argued for a reintroduction of taxes on inheritance transfers between donors and beneficiaries.

Before their staged abolition during the 1970s and 1980s, first led by the Bjelke-Petersen government in Queensland and followed by other states and federally, Australia generally taxed the estate of a deceased person.

In an attempt deter avoidance, Australian governments also taxed gifts made between people while they were living.

As a result of the tax reform initiatives led by the quixotic former Queensland premier, succeeding generations of Australians have been spared the economic, financial, and even personal, pains of having to effectively transfer over to government a share of properties bequeathed to them.

Although the raft of dreaded inheritance taxes are now a historical relic of the Australian tax system, any diligent divorce or estate lawyer would sensibly contend it is erroneous to think that taxation circumstances may not change, in a detrimental fashion, in the event of somebody's death today.

A recipient of an inheritance, say in the form of either shares or an investment property, is likely to be affected by capital gains tax, with the amount of liability likely to be affected by issues such as the inheritor's residential status, the date of the asset purchase, and other practical matters.

The beneficiary of a deceased person's superannuation fund could also be liable to substantial tax liabilities if they are a non-dependent person, that is if they are not the spouse of the deceased person or are not aged under 18 years.

The death of a loved one can even mean an increase in income tax liability for the surviving spouse, because most couples tend to structure their affairs so that they share their income.

In other words, Australia's tax system complexities mean there are numerous stealth "death taxes" that could financially ensnare those grieving the passing of their parent or partner, quite apart from the general efficiency costs of taxes, which reduce capital accumulations over successive generations.

It may be claimed, as the federal government does in its March 2015 tax discussion paper, that a tax on a deceased person's estate would be unlikely to greatly impact savings relating to adequate retirement funding, at the very least because of the way in which working Australians are compelled to hold over money in superannuation funds.

But to introduce a tax on inheritances would act as another bias against savings, in addition to anti-savings taxes such as capital gains and income tax, further constraining our long-term economic potential if implemented.

This is because inheritance taxes would tend to discourage donors from bequeathing their estates to beneficiaries, which would be reflected in increased consumption, and accordingly reduced savings, by those who would otherwise wish to pass on more assets upon death.

With savings representing the effective feedstock of investment activity by the private sector, the imposition of an inheritance tax would, in turn, deter growth in the domestic capital stock to some extent, thereby dragging down future growth.

It is worth remembering that taxes that discourage capital accumulation will hurt workers, in the form of slowing growth of their take-home pay, because working people need to use machinery and equipment to become more productive.

Making matters potentially worse, some start-up entrepreneurs find it difficult to formally access funds from financial institutions, so they rely upon other sources of finance, such as cash endowments from relatives, which could be subject to an inheritance tax.

Even from the perspective of the taxman, seemingly eager to discover as many sources of revenue to financially validate as many forms of spending regardless of their efficiency or effectiveness, it is not even clear that inheritance taxes are worth the effort to implement.

From past Australian experience, not to mention the contemporary experience in Europe and the United States, it is well known that inheritance taxes are prone to avoidance by potential payers, even in the presence of pre-death gift taxes.

Numerous studies have also shown that the costs of complying with inheritance taxes are steep, and not justifiable given the somewhat paltry amounts of revenue raised.

In any case there is some evidence that donors are changing their strategic giving to beneficiaries, for example parents and relatives buying a better education for their children, which would not be well captured by inheritance taxation.

But perhaps the most powerful argument in favour of imposing taxes on inherited assets is that the receipt of supposedly effortless inheritances by a beneficiary leads to an unjustified worsening of material inequalities.

But encouraging a donor to draw down on their savings and blow a potential inheritance on expensive holidays and other consumables, an inheritance tax risks exacerbating the degree of inequality in consumption across the population.

It may well be the case that beneficiaries themselves could consume the inheritance, but such an act, in any event, would tend to dissipate the wealth inequality which persists across generations.

To reduce the degree of wealth inequality in this country it would be far better to target reforms against wealth accumulation which are encouraged by government policies, for example action to deregulate land use which artificially inflates property values.

If there is one tax the Turnbull government ought to safely rule out at this time, it should be the inheritance tax, which does so much to punish the living.

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