What I want to do is think a little bit about the estate tax. As the name implies, it is a tax on someone’s estate when they pass away.
It applies to what they leave behind to their heirs, whether through a will or inheritance. Sometimes it’s referred to as an inheritance tax, and in some cases, people call it a “death tax” in a more critical tone.
The general idea: let’s say my entire net worth is $3 million, and then I pass away. This $3 million goes into my estate, which includes all my savings, stock portfolio, real estate, car, and everything I own.
If I leave everything to my daughter, she would inherit the full $3 million tax-free because, under current exemptions, the first $5 million are exempt from estate tax.
If I were wealthier, say with a net worth of $6 million, the first $5 million would still be tax-free. The remaining $1 million, however, would be subject to taxation at a rate of 35% (based on 2011 rates). This means the government would take $350,000, and my daughter would receive $5.65 million.
Now, consider an extreme example where I have $1,005,000,000. The first $5 million remains tax-free, while the remaining $1 billion is taxed at 35%, resulting in $350 million going to the government. My daughter would be left with $655 million. While a significant tax was applied, she would still inherit a considerable fortune.
If this were a married couple’s estate, the exemption would double to $10 million. So, if my wife and I jointly owned $6 million, my daughter would inherit the full amount tax-free upon our passing.
Arguments For and Against the Estate Tax
Like most taxes, the estate tax is highly debated. Some argue that it is unfair, stating:
- “I already paid taxes on my earnings, and now my heirs are being taxed again!”
- “My children deserve to inherit my full estate without additional taxation.”
The counterargument is that double taxation exists throughout society. For example:
- Corporations pay taxes on profits, and shareholders pay taxes again on dividends.
- Individuals pay income tax and then sales tax when purchasing goods.
Another argument for the estate tax is that it applies only to the very wealthy. Since the first $5–10 million is exempt, the vast majority of families will never be affected. Even beyond the exemption, heirs still receive the majority of the estate (65% after tax).
Preventing the Creation of an Inherited Wealth Class
Some argue that without an estate tax, wealth concentration could spiral out of control. Consider a billionaire who passes down their fortune. If their heirs do nothing and simply let investments grow, the wealth could increase exponentially, far outpacing economic growth. Over generations, this could lead to a small group controlling an outsized portion of national wealth—similar to the aristocracies of old Europe.
Winston Churchill once referred to inheritance tax as a way to prevent a “race of the idle rich.” The idea is that excessive wealth inheritance can lead to a class of people who never need to work, creating economic inequality over time.