Gifts and Inheritance: Any difference?

While it may appear straightforward to tax inheritance income given the perspective that emphasises the receiving side (unearned income) and prioritises negative effects on the living (inequality of opportunity) over the rights of the dead, taxing gifts is slightly more difficult to justify. After all, the giving side is still living in these cases and might claim that it’s a strong infliction on property rights if there is state intervention in the autonomy of gifting.

“The [gift] tax was appended to the inheritance tax and one of its purposes was to prevent the evasion of that tax by means of gifts”.[1]

In many countries (among them Germany), gifts are interpreted as “anticipated bequests” and thus treated under the same law and conditions as inheritance is. A prime reason for this is to avoid inheritance tax evasion by means of gifting. In some countries (such as Latvia and Lithuania), gifts are treated as normal income of the receiving party and thus taxed on the normal income tax regime. Denmark has a mixed regime, applying gift taxes for close family members and normal income tax for other donees. In all cases, taxation of gifts appears to be valid and justified, despite conflicting with property rights.

Tax justifications

When assessing the justification of gift (and inheritance) taxes, we are often comparing it with other taxes such as general income tax. It may be helpful at this point to recall why we are taxing income or consumption (the two most prominent type of taxes) in general. Both taxes are in essence an attempt to measure

“an individual’s ability to bear a portion of the cost of government on the premise that the cost should be borne by members of the public in proportion to their means to do so.”[2]

The ability to contribute is approximated by the size of income and consumption. The two are related to each other, income usually being the sum of current consumption plus possible future consumption. However, some scholars such as Rawls accentuate the difference between the two, where income is contributing to society’s pool of resources, and consumption is solely taking from this pool. Income only potentially but not necessarily leads to consumption and may thus be treated favourably when it comes to taxation. [3] Further, progressive tax regimes (at least for income) are common and attempt to even better approximate the “ability to contribute”.

Taxing income, gifts and inheritance

When we take these arguments back to the gift tax debate, we can see that gifts could be taxed at least as high as ordinary income. Given that gifting does not contribute to society’s pool of resources, forms a source of unearned income, is not the result of an agreement that all parties agreed on (such as a lottery, see chapter above), and can have severe detrimental effects on equality of opportunity, even higher taxes than on income appear justified. Lastly, gift taxes need to be as high as or very close to inheritance tax rates to avoid tax evasion, that is, individuals misusing gifts as a means of “anticipated inheritance” to avoid inheritance taxes. Interestingly, the influence goes both ways: Gift taxes constitute the lower end of meaningful inheritance taxes. Given that the donating party is still alive, there may be small but siginifact reasons for taxing gifts slightly lower than inheritance taxes. Different from what we see in some tax regimes, where inheritance taxe rates are lower than income taxes, a just tax regime appears to be one in which income tax rates are lower than gift taxes which in turn should be slightly lower or close to inheritance tax rates.