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Death duties, where angels fear to tread

If advocating additional taxation is unpopular with the public, little provokes as much antagonism as the mere mention of death duties. In Australia, it is a truism that any leader contemplating death duties must be morbid, endowed with a fetish for political suicide.

I believe it is time to question this superstition. Holy cows need periodical poking in the ribs, however anathematic to the faithful.

Government revenue growth must come from somewhere

Given the outlook for budget deficit, global uncertainties and political point-scoring about ‘the other side’s tax grab’, treasurers and civil servants have been forced to conjure up incremental measures from a list of possibilities of diminishing utility. In superannuation, the superannuation surcharge (which its architect Costello later contritely despised), the complex contribution caps and the proposed taxation of earnings during pension phase exceeding $100,000 per member come to mind.

It is naive to ignore a potential source that remains untapped for reasons of apathy, inertia or false ideology. The pressure to plug the deficit is unrelenting, while pensioners post 60 receive tax-free benefits from tax-exempt accretion of savings. Social security asset limits ignore the family home, which remains exempt from capital gains tax as the primary residence.

Dislike of death duties

Why the antipathy to death duties? Several reasons suggest themselves:

  • Having accumulated assets during life after paying taxes, it seems a double whammy to extract another dose.

  • Such taxes will be a disincentive for people to work harder, earn more, prudently save for a rainy day during life and arrange for the eventual care of the family – all attributes of a civilised, as distinct from subsistence, society. Progress and social cohesion depend on them.

  • People already suffering from the trauma of the demise of a dear relative do not need the angst of the savings of a productive life, being dissipated by the grasping taxman.

  • There is something morbid, redolent of grave digging, in extracting taxes from the dead. Are we that low to pick, hyena-like, on our dead?

On closer scrutiny, many of these legitimate convictions exhibit the classic features of ancient myths no longer relevant in, or affordable to, contemporary society. Consider the following:

  • Society incurs a cost in facilitating the orderly enjoyment of accumulated assets, regardless of the owner’s physical existence, and this has to be paid for. Why not seek a contribution from the users? Multiple incidence of taxation is not as uncommon as the argument presumes: for example, consumption of post-tax income is subject to a variety of cascading taxes. Therefore, it is a question of distributing the impost equitably across a range of taxable amounts, including bequests. The larger the taxable base, the better.

  • The progressive system of taxation, almost universally preferred, does entail more from the better off, as a proportion of the taxable base. The alternatives (regressive and flat systems) will impose a heavier burden on the lower earners. It is possible to set tax rates such that the desired goals (incentives for work, prudent savings and providing for the family) are balanced against a fair and reasonable levy, without treating the two as mutually exclusive.

  • The argument of additional trauma for the family is disingenuous, at best. As long as the tax rate is set unambiguously and administration simple, those remaining can and should consider the net of tax legacy in remembering the deceased. Bequests incur a host of other costs: professional fees, stamp duties, custody and execution charges. No one begrudges them. Inheritance taxes merely conjoin the twin certainties of life in one convenient step.

  • Bemoaning the dissipation of wealth upon death ignores hard reality: death deprives humans of all physical possessions. Why pretend inheritance is an exception? The obvious motive is the entitlement mentality of those who remain.

  • The conflation of inheritance tax with the purported ill-treatment of the departed conveniently glazes over the fact that in the astral world beyond, the ATO writ does not run. As we find it acceptable to tax the living to foster social order and equity, even if it results in severe hardship to the lower levels of economic strata, it must be a no brainer to ‘tax the dead’.

The arguments for death duties

Putting aside the emotional reaction, there are solid arguments in favour of the tax:

  • The criteria for a good tax system are equity, ease of collection, re-distribution of income and wealth, capacity to pay, incentive to earn and efficiency, combined in optimal balance. The imposition of inheritance tax would not offend any of the above.

  • Tax avoidance is a major problem that deprives the exchequer of money, time and effort. Given the existing system of distributing deceased estates, it should be relatively easy to guard against abuse, with appropriate recourse against the inherited assets.

  • Tax is global in its reach. Those tempted to game the system across national economies because of Australia’s current practices might find it is less advantageous, if the inheritance anomaly is corrected. While this might call for an incremental tweak of the system, it would be worthwhile to preserve equity.

  • Most of all, the emerging outlook cries out for a replacement of the current system’s propensity to push funding costs as a future burden on successive unborn generations. Consider unfunded social security and government pensions on the one hand and the need for a government push into long term infrastructure funding (even if it is as a co-investor with other long term investors). There is something amiss in a society that taxes the average worker on incomes of $37,000 per annum, while letting current consumers past their working lives to enjoy tax-free pensions and lump sums, regardless of size, and then able to pass on the balance gross of tax to their offspring. It is neither welfare nor equity.

Ignoring inheritances misses a vital option. In superannuation, the nation is faced with managing longevity as more members move into the pensions phase, free of earnings and benefits tax. We need a circuit breaker, in addition to innovative policy. Inheritance taxes could be the circuit breaker.

Ramani Venkatramani is an actuary and Principal of Ramani Consulting Pty Ltd. Between 1996 and 2011, he was a senior executive at ISC/APRA, supervising pension funds.

 

7 Comments
Ramani Venkatramani
November 08, 2013

Thanks for the comments for and against (and the effect of death duties on future mortality, hitherto unknown to the actuarial profession!). I will consider them carefully and respond in a brief follow-up article on Cuffelinks.

Sonia Main
November 04, 2013

There already is a death duty. Superannuation death benefits are only tax-free when paid to dependants under tax law, which are defined as a spouse and children under 18 (with some exceptions). Otherwise, pass your superannuation to your older children and the taxable component is subject to a 15% tax plus Medicare levy. Not enough attention is paid to this. For example, it would be better just before death (if it could be planned) to cash in the super and add it to the non-super estate, where it avoids the tax in the hands of the non-dependant child.

Richard
November 03, 2013

Let me give another perspective. Not death duties but inheritance tax.
We have a strange system
Income taxed in full
Capital gains on 50%
Gambling and inheritances at nil

Why not tax inheritances of say over $200,000 at 25% as ordinary income.

There will have to be exemptions for spouses and some others (superannuation death benefits give a model)

Chris Eastaway
November 02, 2013

Andrew,

The answer seems quite simple really. In the first case - that a family business may need to be broken up in order to pay the death tax - the burden of responsibility is on the family to adequately inure against the tax liability through life or other kinds of insurance (more than likely through superannuation). The living must guard against the loss of their assets (such as the family home) in the event of the death of a main bread winner. Think about any family who have a mortgage larger than can be sustained on one wage! So it seems reasonable to assume the same standards in the case of any business who suffers from illiquidity. As we would simply sell enough of the family business to cover any tax if that business were able to be split illiquidity is the root of your issue, not the tax.

In the second case it should be remembered that no matter how close together the death of family members the tax can’t, and wont, be the equivalent of 100% of assets. Regardless of how much the departed leaves behind there will always be something for the airs. How much, of course, is a matter of what was achieved in life, not death.

I agree with Ramani’s view that these arguments only aid the entitlement mentality of those who remain. Unfortunately I'm friends with a great many people who suffer from entitlement disease. They look forward to their inheritances as some God given right. Not many consider the absolute conditions precedents required for their receiving the money either! Which you would think, if they were rational and loving, would be a major deterrent for them ever wanting to receive the money. Fewer still, but certainly present, are the people I know who will achieve very little in life due to the expectation of great wealth removing the gift of motivation from their lives.

So perhaps that’s the flip? An argument that death duties might motivate the living!

Anon
November 01, 2013

I think death duties are an appalling tax, particularly because our elderly will start to worry excessively about it and we should instead be trying to give them some calm twilight years. For example, they will try to give their assets to their children before they die and might end up with no money at all. Or their child's wife subsequently walks out and half the house which should have been earmarked as inherited is lost from the family assets. A couple of generations ago, our great grandmother's husband was murdered as he was transporting the day's takings to the bank and she had to sell the small holding generating fruits and vegetables for the market (the family's source of income) to pay death duties. After loans were paid off, there was nothing left and the family was destitute, with no source of income. I remember she used to repair umbrellas in order to support two small children and the eldest child had to leave school at 12 years old to earn an income. There are plenty of ways to tax the living instead.

Andrew
November 01, 2013

The reasons in the article are not the main ones I have heard before against death duties. The biggest concerns I have about them are:
They break up family businesses, particularly asset rich ones like farms, as they too often leave the successor generation with a massive tax bill they have no capacity to pay and no choice but to sell up and start from scratch, and
The impact of multiple deaths in a short space of time can be utterly devastating to a family - ie patriarch (or matriarch) dies at an advanced age, then shortly after one of the next generation dies - two hits of the tax in a short space of time, again leaving no capacity to pay.
Unless they can be structured to avoid those types of impacts (and I'm not sure they can be) then they should remain consigned to history.

Alex
November 01, 2013

I recall a study that showed announcing the abolition of death duties led to a delay in deaths until after the duties were no longer in place and another that saw deaths brought forward before new duties would come into effect. Once in place, death duties would act like a lifetime annuity, giving an extra incentive to stay alive.

 

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