Reform Options for the Estate Tax System: Targeting Unearned Income

Senate Committee on Finance • March 12, 2008 • Tax Policy

Lily L. Batchelder • Former Associate Professor of Law and Public Policy, New York University School of Law

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Good morning, Mr. Chairman, Ranking Member Grassley, and Members of the Committee. My name is Lily Batchelder and I am an associate professor at NYU School of Law. Thank you for the opportunity to testify before you today on alternatives to the current federal estate tax system. My testimony makes three main points:

  • First, inheritances tend to exacerbate existing economic disparities and may be the most important barrier to intergenerational economic mobility. These tendencies are most pronounced at the top of the income distribution. Inheritances are a significant component of household income. They are also the source of about 40 percent of all household wealth. While inherited income is distributed fairly evenly across most of the population, it rises sharply at the very top. Among households receiving a bequest in a given year, the average inheritance of those in the top 1 percent of the inheritance distribution is 34 times larger than the average inherited income of everyone else.
  • Second, the estate tax system is the most important mechanism by which the current fiscal system mitigates the effect of inheritances on economic disparities and intergenerational mobility. The burden of the estate and gift taxes falls largely on heirs, not donors. On average, it also rises rapidly with the amount the heir inherits and his economic income.2 Nevertheless, the relationship between the heir’s financial circumstances and his or her estate tax burden is relatively imprecise. Some individuals who receive extraordinarily large inheritances bear little or no tax burden, while a small number who inherit relatively small amounts bear substantial tax burdens.
  • Finally, the scheduled repeal of the estate tax in 2010 and reinstatement at higher levels in 2011 create an opportunity to better focus the estate tax system on unearned income that inheritances represent. We should use that opportunity to reform, not repeal, the estate tax system so that we continue to tax inherited income, but in a more equitable manner. I will discuss two potential reform options.

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