Friday, December 27, 2013

Giving to the next generation

Australians may be generous than others in leaving behind a legacy for their family members, but should those inheritances be taxed?

A recent survey by international financial services company HSBC found that 69 per cent of Australian retirees planned to leave an inheritance for their families.

The average value of inheritance expected to be left behind by retirees in this country, of about $US 502,000, is estimated at more than four times the average of other countries surveyed.

A spokesperson for HSBC credited the great Australian appetite for making bequests to strong annual average growth in household wealth, driven partly by high and rising house prices.

Another cited factor informing Australia's position on top of the international inheritance league table is the lack of inheritance taxes, compared with other developed countries, such as the United Kingdom and United States, with large inheritance taxes and smaller average bequests.

Australia owes much to this legacy, in that we have enjoyed lower tax burdens as a result, but arguments favouring inheritance taxes, both here and abroad, linger.

The Australian Greens have favoured inheritance taxation in the past, while now Labor MP Andrew Leigh wrote in 2006 that reinstating an inheritance tax on the super-rich would be consistent with the Australian values of egalitarianism and the fair go.

A bequest tax was also recommended in the 2008 Henry Tax Review final report, on the basis that more revenue could be extracted from wealthy households.

One of the more unlikely sources favouring inheritance taxation was former Nobel Prize economist, and highly-regarded defender of markets, James Buchanan, who went so far as to advocate a 100 per cent tax on bequeathed estates.

As far as the economic arguments go, the case against re-introducing inheritance taxation in Australia seems reasonably straightforward.

Taxes on inheritances would tend to discourage donors from bequeathing their estates to beneficiaries, which in turn increases consumption, and reduces private savings, by those who wish to pass on their 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 capital accumulation.

An important, though often overlooked, aspect of this argument is that some start-up entrepreneurs find it difficult to formally access funds from financial institutions, and so inheritances, particularly cash endowments, represent the key initial financing source for many prospective ventures.

However, it appears, at least for some people, that non-economic, or more specifically, ethical, arguments for inheritance taxation override the adverse economic consequences of such impositions.

There appears a widespread distaste of unearned income or wealth windfalls, with bequests seemingly resting alongside lottery winnings and natural resource discoveries as some of the more unpopular forms of unearned wealth acquisition.

A source for the distaste towards inheritances, and hence support for inheritance taxation, is that not everyone can voluntarily endow others with bequests in equal measure, and so without taxes equality of economic opportunities would be foregone.

Putting aside that the productive usage of bequests by donors, for example to establish or expand a business, can deliver widespread benefits to non-beneficiaries, distinctions between unearned and earned income, or wealth, seems too indiscriminate for clear guidance.

For example, other forms of unearned gain, such as Christmas presents, birthday gifts, or charitable donations, do not earn public rebuke, and attract calls for their taxation, in anywhere near the same intensity as inheritances do, if at all.

Classical liberals more appropriately distinguish between incomes and wealth attained either through voluntary means, say, by earning a wage or receiving a gift or donation, or through coercive means, say via government subsidies, tax breaks or regulatory holidays.

According to this perspective, voluntary transfers should ideally be left untouched by inheritance taxes or other coercive instruments that serve to expunge justly acquired property, whilst the coerced transfer of incomes and wealth should cease.

This approach would ameliorate the prospect that inheritance taxes would unintentionally level down the attainment of opportunities in society, whilst simultaneously ensuring that artificial privileges, such as those acquired through longstanding crony relationships between governments and businesses, are eliminated.

A final twist is served by James Buchanan's argument that beneficiaries will wastefully expend resources to secure favouritism, and thus greater shares of the inheritance, from the donor, and thus taxes are required to prevent such perceived wasteful conduct.

It is difficult to surmise why such conduct by potential recipients would necessary represent a social cost borne by the entire community, and not a cost borne primarily, and willingly, by the individuals involved.

Furthermore, using the blunt instrument of taxing intra-family income or wealth transfers is likely to come at the inappropriate cost of penalising transfers made in the cause of genuine affection between family members.

Inheritance taxes were relegated to the dustbin of Australian fiscal history during the late 1970s to early 1980s, through tax abolition initiatives at both federal and state levels of government.

These actions have proven to be far-sighted ones and so, in the interests of avoiding higher taxes on Australians, it is best not to resurrect this odious tax idea which fails on economic and ethical grounds.

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