Nearly twenty-seven years ago, Australia became the only developed country in the world without an inheritance tax. Changes instituted by Prime Minister Malcolm Fraser, and John Howard (then known as ‘the boy Treasurer’) abolished inheritance taxes for anyone who died after 30 June 1979. Today, the ‘land of opportunity’ is still one of the best places to be born with a silver spoon in your mouth.
We believe that reinstating an inheritance tax on the super-rich would be consistent with the Australian values of egalitarianism and the fair go. An inheritance tax would be an efficient way of raising revenues — causing fewer distortions than income and sales taxes. An inheritance tax would also help address Australia’s low levels of philanthropy, and give social entrepreneurship a much-needed shot in the arm.
Equitable, Efficient and Simple
For a generation, Australia has stood apart from every other developed nation in not taxing inheritances. (Although Canada abolished its inheritance tax in the 1970s, it now taxes realised capital gains at deathamounting to a de facto form of inheritance tax.) Their abolition was a product of several disastrous decisions. While other developed countries reacted to the rapid inflation of the 1970s by adjusting upwards their inheritance tax schedules so that inheritance taxes applied only to the very rich, Australia allowed middle-income estates to come within the ambit of inheritance taxes. In 1977, Queensland abolished inheritance taxes. Federal inheritance taxes ceased to apply two years later.
From a pure economic rationalist perspective, there is a good case to be made that the abolition of inheritance duties was a mistake. Basic public finance dictates that taxation should aim towards equity, efficiency and simplicity. On equity and simplicity grounds, inheritance taxes compare very favourably to other forms of taxation. But what is often not recognised is that inheritance taxes are also an efficient form of revenue-raising.
Efficiency requires that taxes should minimise distortions to the economy — or in the words of Louis XIV’s finance minister, Jean-Baptiste Colbert, to pluck the maximum amount of feathers from the goose with the least amount of hissing. Most taxes involve some distortion of economic activity. Income and payroll taxes reduce the incentive to work. Capital gains taxes reduce the incentive to save. The Goods and Services Tax reduces the incentive to spend on GST-liable products and services.
How do inheritance taxes compare? A number of prominent economists, including John Stuart Mill, Arthur Pigou, Richard Musgrave and Joseph Pechman, have argued that inheritance taxes probably have lower efficiency costs than taxes on labour supply and savings. The question is a complex one — as William Gale and Joel Slemrod have pointed out, it depends partly on the fraction of bequests that are ‘accidental’. But in our view there is a strong case to be made that inheritance taxes are more efficient than most other forms of taxation.
A Boost to Philanthropy
Another advantage of inheritance taxes is their potential to boost charitable giving. Unfortunately, Australia has never had a tradition of big-ticket philanthropy; we can boast of no Rockefellers, Carnegies, or Morgans. Even today Australian philanthropy is minimal. Overall, while Americans give 2 per cent of their incomes to charity, Australians give less than half a per cent. At the very top, a study by Andrew Leigh and Justin Wolfers estimated that America’s richest man, Bill Gates, had given around one-third of his income to charity, but that by the time of his death in 2005, Kerry Packer had given less than one-twentieth. There are some exceptions to this patternsuch as the recently established Lowy Institute for International Policybut, on the whole, Australia’s silvertails are more likely to leave behind rich children than well-endowed foundations. Few seem inspired by John D. Rockefeller’s belief that ‘anybody who dies rich dies disgraced’.
Part of the reason Australians are ungenerous in their giving appears to be cultural. Australians commonly believe that it is through our taxes that we build the infrastructure of community life. Many feel that we are highly taxed, and that once we have paid our taxes, we have discharged our social obligations and are absolved from the need to provide additional individual charity. Yet Australia is not a highly taxed nation. According to the OECD, Australia has the third lowest rates of overall taxation across the developed world at 29.9 per cent of GDP, with only Japan (28.4 per cent) and the United States (28.9 per cent) below us. More than many other nations, Australia needs philanthropic contributions.
Charitable giving is inextricably linked to the tax system. Indeed, US tax expert William Zabel has gone so far as to argue that ‘most philanthropy is tax-motivated’. Today, the absence of an inheritance tax encourages philanthropic inertia: why think about charitable giving when you can put it off to the next generation? Reintroducing inheritance taxes would be one way to encourage the very richest Australians to give more back to our community.
A Modest Proposal
We believe that Australia should have a millionaires’ inheritance tax, to facilitate greater philanthropy. Intended to apply only to the super-rich, the tax would work as follows. For estates above a $1 million threshold, a tax rate of 5 per cent would apply, rising to 15 per cent on inheritances over $2 million. For estates worth less than $1 million, no tax would apply. We estimate that a millionaires’ inheritance tax today would be paid by less than 1 per cent of the population. Notwithstanding Sydney’s sky-high real estate values, it is still exceedingly rare for one person to own a house worth more than $1 million (or for a couple to own a house worth more than $2 million). To put the inheritance tax threshold into perspective, the average Australian will see his or her lifetime wealth level off at just a quarter of this amountaround $25 0 000.
We recognise, of course, that one of the greatest fears surrounding an inheritance tax is that it will catch ordinary Australians, as the 1970s tax once did. To remove this possibility, the $1 million inheritance tax threshold should therefore be indexed to the national wealth. That way, the new inheritance tax should always remain a tax on the super-rich, not on middle-class Australians. And to allay another common concern, inheritance tax payments should be deferred in situations where they would cause hardship to farmers or families owning small businesses. The inheritance tax would be constructed so as to include all gifts given in the twenty years before death (except to charities), so the super-rich cannot bypass the tax through gifts, trusts and other schemes. Such a modest system of inheritance taxes would likely generate revenues of less than $1 billion per year. But the boost in charitable giving may be at least as large, as the most affluent increase their donations in order to reduce their tax bill.
By comparison with estate taxes in the United States, our proposal is relatively modest. In 2006, US estate duties apply at a rate of 46 percent to estates worth US$2 million and over. Although reforms instituted in 2001 aim to abolish the US estate tax by 2010, the political consensus for abolition is fragile, and many expect that the country will maintain some form of inheritance tax on the super-rich.
Like all forms of taxation, inheritance taxes are not a punishment for doing well. Australia’s wealthiest peopleentrepreneurs, successful managers and entertainershave much to be proud of. Their wealth is usually the result of hard work, and they should be allowed to give a substantial portion of it to their heirs. An inheritance tax for the super-rich is an efficient way of encouraging these Australians to give back to the community that helped create their wealth. Indeed, this is one reason why some billionaires, including Warren Buffett and George Soros, have opposed the reduction in the current US inheritance tax.
Reimposing inheritance taxes would be an equitable and efficient tax reform, which would also create a strong incentive for the rich to reduce the size of their inheritance through donations. We recognise that it is received political wisdom that inheritance taxes can also be spelt p-o-l-i-t-i-c-a-l s-u-i-c-i-d-e. But since we are the only developed nation not taxing inheritances, it is time to challenge this received wisdom. There is too much at stakea substantial increase in charitable donations and a valuable boost to disadvantaged communitiesnot to do so.