Second-best at best: Why a wealth tax is no alternative to inheritance tax, nor a very good complement

In the discussion of inheritance taxes, wealth taxes feature prominently, sometimes as a useful complement, but often as an alternative. Where inheritance and gift taxes are one-off transfer taxes, wealth taxes usually occur annually. Wealth taxes aim at the total stock of wealth at a given time, whereas inheritance taxes aim at the inflow of additional wealth.

Economists favour inheritance taxes over wealth taxes^[1] for economic efficiency reasons and (maybe conversely) inheritance taxes have been more widely applied than wealth taxes across countries and time. Recently, however, there is a rise in popularity of wealth taxes in academia, politics and public opinion. Figure 1 shows how wealth taxes have nearly doubled in their mentioning in Google Books over the last 10 years, while estate, inheritance and death taxes are on decline since 20 years or longer.

Figure 1: Comparison of popularity of wealth vs. inheritance/estate/death tax over time.
Google Books corpus in English language (Google Books Ngram Viewer).

This is mirrored by the significant trend towards abolishment of actual inheritance, estate and gift taxes in the last 15 years (see Figure 2). While wealth taxation has undergone a similar, though longer and slower trend towards abolishment, the number of countries with a wealth tax has recently started to increase again with Bolivia and Columbia joining the group. This is in line with the global discourse around the matter: A global minimum wealth tax on the very rich is discussed currently^[2], accompanied by various national debates about (re-) introduction of wealth taxes such as in USA, Germany, Austria, UK and South Africa.

Figure 2: Number of Countries with existing Estate/Inheritance or Wealth Tax Regime. Source Estate/Inheritance Tax data: Morelli et al. GC Wealth Project Data v.1, accessed via http://wealthproject.gc.cuny.edu, on 18.11.2024. Variables: x-hs-agg-eitrev-00. Source Wealth Tax data: OECD “Comparative tables of Revenue Statistics in OECD member countries”, accessed via https://data-explorer.oecd.org/ on 18.11.2024.

Arguments in favour of wealth taxes and why they don’t hold

The following sections analyse the arguments for and against wealth taxes as an alternative or complement of inheritance taxes. We will focus on the differences between wealth taxes and inheritance taxes, and not reiterate on the general line of arguments that apply to both inheritance and wealth taxes, such as rising inequality levels.

Fixing a broken tax system?

Often, a wealth tax is brought forward as a way to fix broken tax systems that have become less progressive over time or even regressive for very high incomes. Through tax evasion and avoidance and tax systems that treat capital income more generous than wage income, the effective tax rates of very high incomes fall far below the peak tax rate for wage incomes. These effective tax rates of the very wealthy are often around half of the top marginal income tax rates, that is. around 15-25% vs. 30-50% peak income tax rates.

In this context, wealth taxes are proposed as a means to make sure the rich are also contributing their fair share. Without a wealth tax, the argument goes, the very wealthy structure their wealth in a way that they only receive little private earnings (on which they would have to pay relatively high-income taxes), and keep most of their wealth contained in holdings and other investment vehicles that allow the fortunes to grow with minimal taxation involved.

This is a fair argument at first sight. Inheritance taxation would not be able to address this shortcoming of current tax systems. However, it remains unclear why a dedicated new tax is necessary and why the lack of progressivity at the upper end of the income distribution could not be fixed within the existing framework of income or consumption taxation: Attempts could be made to undo the privileged treatment of capital income over labour income that may fulfil the same purpose as a wealth tax. It is unclear why a wealth tax should be chosen over those more direct attempts to correct the well-established shortcomings of our current tax systems.

Some possible steps that could be taken without a wealth tax but with a similar “repair” effect on the above-mentioned shortcomings of current tax systems would be:

• Tax unrealised capital gains through inheritance and gift taxation à stepped up valuation basis
• Tax unrealised capital gains through exit taxation à stepped up valuation basis
• Tax unrealised capital gains through property taxes based on market prices instead of purchase prices or outdated valuation standards
• Remove exceptions on capital gain taxation (e.g. the option of selling real estate tax-free after a certain holding/speculation period)
• Remove privileged tax treatment of interest over other forms of capital gains or employment income

Inheritance tax not powerful enough? They could be!

Some scholars argue for a wealth tax from an entirely different perspective: they hold that even a strong and well enforced inheritance tax would simply not be sufficient from a tax justice perspective, and that a wealth tax would be much more effective in this respect. Even a strong inheritance tax would make little difference to the effective tax rates of ultra-high-net-worth individuals because only levied once—at the time of death—and thus generating significantly less revenue than annual taxes.^[4] Simulations for France show that even with effective average taxes rates of above 40% for the very wealthy, the ratio between inherited wealth of very wealthy vs. the median heir would be around 40, and thus not be in line with equality of opportunity.^[5] The authors of the simulation study find that in order to reduce this ratio to truly level the playing field, one would have to increase the inheritance tax rate even further, which they deem to be politically and constitutionally unfeasible.^[6] Additionally, the 50% of the population who do not inherit anything would have to benefit from a significant initial endowment at birth in order to close the gap between heirs and non-heirs. A universal initial endowment large enough to level the playing field is not feasible to be financed from the inheritance tax revenue of their model, the authors argue.

These findings should be of no surprise even without any complicated simulation. If you are not willing or able to take away 50% of inheritance or more and redistribute it to those who don’t have anything, mathematically we cannot come close to any form of equality of opportunity. This is intuitive if you think about a simplified society where one person owns all wealth, and one person has nothing. You need to take away 50% from the wealthy person and give it to the poor person, in order for an equal financial position. Of course, in cases where some few people own majority of wealth, and many, many others have little or nothing (as in our actual societies), you need to tax the few rich ones even far beyond 50% in order to be able to put everyone on the same financial starting position in life.

Overall, the argument in favour of wealth taxes based on the alleged insufficiency of inheritance taxes is not convincing. If you are willing to instate high inheritance taxes, and combine it with an effective progressive income tax scheme, there should be no further need for a wealth tax. If you cannot do either for political or whatever reasons, yes, then a wealth tax may be a second-best solution to achieve similar goals.

Figure 3: Average tax rates by income group. Source: Zucman (2024)

Preventing concentration of power

Another prominent line of arguments for wealth taxes stems from its potential to limit the concentration of power. This is based on the idea that excessive wealth accumulation puts the wealthy into positions of power and influence that may be harmful for our democracies which were supposed to function on the 1 person-1 vote principle. This argument calls for wealth to be controlled, irrespective of the way this wealth was created. This means that even if we had 100% inheritance taxes and a functioning progressive income tax system, a wealth tax may still be desirable in order to limit excessive concentration of power.

Is wealth related to power, and if so, is this problematic? Studies have shown how political decisions reflect the interest of the rich as opposed to the interests of the poor. Wealth translates into political representation. There are various possible reasons for why political decisions are leaning towards the interests of the wealthy. Politicians themselves are often not representative in terms of wealth and education for the country at large, which can explain why they may represent certain interests more than others. The same goes for other forms of political participation, incl. the mere act of voting. Poorer people tend to vote less, and thus find less political representation. Finally, wealthy people tend to be better connected to other elites, incl. political elites in parties, governments, and in public offices. While these findings may not be intentional misuses of power, they remain unsatisfying from a democratic perspective that aims for just and equal political representation.

There are more direct interferences of the wealthy with politics which may fall under illegit power abuse, e.g. when political decisions or elections are influenced actively by large-scale donations to political parties, or when a certain media takes side in political matters in line with the interest of the wealthy individual or groups that own the media. Both cases, campaign donations and media control, have been found to be important and successful political influence mechanisms. Other potentially problematic ways of influencing politics directly by using wealth privileges are: excessive (and untransparent) lobbying, public relations campaigns, financing think tanks.

Where a wealth tax is justified by the goal to protect our democracies against concentration of power, it may just be the wrong tool for the right goal. A wealth tax is the wrong tool here, because it assumes holding wealth necessarily comes along with problematic power accumulation. It equates financial power with power abuse potential. However, first, there are other sources of power which society also does not restrict, e.g, popularity, network, reach and skill, which also have misuse potential. These may often coincide with wealth, but are not inherently the same. Also, only because you are a self-made billionaire, you may not want to misuse that power. Wealth tax, if justified by a fear of power abuse, assumes you will, or you may, at least. Lastly, and most importantly, there should be more direct means to control the potential for misuse of power that comes with excessive wealth, such as:

• Monopoly commissions to prevent the growth of large monopoly corporations that gain to much market power by a lack of competition. Market power is somewhat linked to political power, because it reduces the consumers ability to punish a corporation for inappropriate political interference. Take the example of Elon Musks interference in the 2024 presidential elections in the USA, where he effectively bought voters with money to vote for the Republicans. If you dislike this anti-democratic behaviour (no matter which party preference you have) and would like to stop consuming products from Elon Musks businesses, you may struggle to do so if you are a user of X (formerly Twitter) due to its near-monopoly market share and importance as a communication channel. Even when buying an electric vehicle, Teslas dominance in the market means if you want to avoid this business, you have a substantially reduced palette of good alternatives to choose from.
• Media restrictions: The case of X and Elon Musk illustrates another problem: Media ownership and political power. With a controversial billionaire taking over an important media that plays a key role in political debate and opinion formation for hundreds of millions of people, there is justified worries for a misuse of power that clearly stems from wealth here. Without the necessary funds, Musk would not have been able to get into this position of control. Restrictions on media ownership and concentration should help.
• Restrictions around political donations, lobbying and other means of political influence: These include limits to how much an individual person or corporation can donate to a party or campaign, full transparency on political donations, stricter lobbying laws, stricter conflict of interest laws, public funding for political campaigns, limits on political ad spending.

The same thought as above, that wealth taxes are an imperfect and very indirect means to achieve the desired end, also goes for political representation. Only because currently, there is a correlation between wealth and political representation and that is found to be problematic[7], it doesn’t mean taxing wealth is the only or best way to fix this problem. The following could be more direct ways to improve political representation without having to temper with a very indirect lever such as the wealth tax:

• better political education in schools or through public agencies and programs
• quotas for underrepresented groups in parliament
• easier voter registration (e.g. automatic without the need to manually sign up for the ballot) and easier voting systems
• participatory budgeting
• citizens councils
• reducing wealth barriers to politics (e.g. through a universal basic income or inheritance)

Political Feasibility

When confronted with the problems of a wealth tax as opposed to alternatives like strengthening inheritance tax and (capital) income tax, a final and desperate argument that is sometimes voiced is that a wealth tax is simply politically more feasible and opportune. This notion is backed by the statistics we presented at the opening of this chapter on the growing relevance of wealth taxes in public debate vis-à-vis inheritance taxation. Matching these trends, public polls reveal that wealth taxes are substantially more popular than inheritance taxes among the general public, see chart below. 

Figure 4: Public support for wealth taxes vs. inheritance taxes according to recent polls.^[8]

Is political feasibility a legitimate and convincing argument? In cases where two taxes have similar advantages and disadvantages, one may decide to lobby in favour of a proposal that is likely to get most support and least resistance. In cases where one tax clearly seems superior over another, it is questionable whether the feasibility argument is very meaningful, unless the difference in feasibility is so strong to render the superior option completely impossible.

Additionally, the political feasibility argument may only be used ex-post, after a deliberation about the right choice of taxes has been made. It is, however, not really a meaningful argument within the deliberation process, as the outcome of any deliberation process may influence public opinion. As such, what is politically feasible is determined by what people think and how people feel about certain taxes, which of course partially depends on the discourse and the arguments brought forward and against these taxes. There is growing evidence that informing people with some more background on the topics related to wealth and inheritance taxes can change their opinion about the tax. Public understanding of inheritance and wealth taxes is often limited, with people significantly overestimating the tax burden and its reach. Studies highlight mixed effects of providing accurate information: while some older studies reveal limited changes in attitudes, more recent studies largely find providing information increases support for redistributive policies.

Arguments against wealth taxes

The less liberal choice

Taxing wealth on a regular basis as opposed to taxing inheritance is morally and economically much more difficult to justify. Wealth taxes are rather working towards equality of outcome than towards equality of opportunity, and thus to be avoided as much as possible from a liberal perspective. Abolishing inheritance or high inheritance taxes can indeed be used to reduce the need for income and wealth taxes.

Social-liberalism values the elimination of privilege without aiming to equalize outcomes entirely. From a social liberal point of view, inheritance taxes are superior to wealth taxes, as they align better with the principle of equal opportunity.

Inheritance taxes do not infringe upon personal property rights during an individual’s life, since these rights naturally end with death. Thus, inheritance taxes enable wealth redistribution across generations without punishing personal merit or confiscating assets from individuals against their will. By contrast, wealth taxes interfere with an individual’s property during their lifetime and may discourage financial success, which contradicts social-liberal values of rewarding merit and effort.

From this social-liberal viewpoint, inheritance taxes are preferable, as they support opportunity for all while preserving individual freedoms. Revenue from inheritance taxes could also help reduce reliance on income and wealth taxes, balancing fairness with incentives for personal success.

The less efficient choice

Wealth taxes are criticised for being relatively inefficient in terms of their collection cost: They are said to be relatively costly to administer and collect in relation to their revenue potential. This has various reasons. Compared to inheritance taxes, which are only due once a life-time or in the form of gift taxes only every other year with every larger gift, wealth taxes are usually levied annually. This means, the assessment of the taxable basis of wealth needs to happen yearly. Given that wealth is not only conveniently held in bank accounts, but spread across various asset classes such as real estate, stocks & shares, precious metals, art, etc., taking stock of a everyone’s wealth annually is a major exercise. An advantage of inheritance taxes is that some kind of stock-taking at a person’s death has to happen anyway, in order for succession and transfer purposes, irrespective of any taxation. This would even hold in a system of 100% inheritance tax where private inheritance would be abolished and property fall to the state or community after death; an assessment of property after a person’s death will be necessary in all cases.

It is argued that the cost of wealth assessment is quite large, as estimating wealth can be complex. It can involve external appraisers, and potentially court involvement if tax authorities and taxpayer don’t agree on the evaluation of property. Additionally, like any tax, there are also cost on the side of the taxpayer, e.g. tax consulting and the work and opportunity cost of filing the tax declaration. The estimated cost varies widely depending on key assumptions on the frequency and cost of external appraisers, on the time spent by the tax authorities’ employees on each declaration case, on the hours each tax payer spends on the tax declaration, on the average amount of tax consulting cost per tax payer, etc. For Germany, studies have estimated anything in the range of 1-2%^[9] on the lower end up to 20, 30^[10] or even 50%^[11] of the estimated tax revenue of a wealth tax. Of course, these cost shares additionally depend on how often the tax has to be declared (annually, bi-annually, etc.) and how encompassing the tax is. A wider scope of the tax in terms of larger coverage of asset classes can make estimation more complex and cost shares rise, a wider scope in terms of wealth and people covered can raise the estimated revenue and thus lower the cost share. A recent study for the UK, reviewing historical data and various other studies, settles on an estimate of about 15% overall collection cost for 1% annual wealth tax in the UK.^[12] Despite not as high as often quoted by the critics of a wealth tax, this still constitutes a substantial economic cost.

How does this compare to inheritance tax collection cost? The estimates vary about as much as for wealth taxes, as they suffer from the same dependency on sensitive assumptions and measurement problems. For Germany, there are recent estimates in the range of 1-4%^[13] for the total collection cost, which are roughly in line with older estimates of 3.7% for the public administration cost alone^[14]. For the US, the tax collection cost of the estate tax has been estimated with 7%.^[15]

For the UK, compliance cost have been estimated at 0.6–0.7% of the estate value.^[16] In relation to the standard rate of 40% inheritance tax rate in the UK, this would translate to 1.7% collection cost in relation to inheritance tax revenue. This, however, is simplified, as the effective average tax rate is not 40%, but closer to 4%.^[17]  Applying this rate would yield around 17% collection cost. An accurate estimate lies probably somewhere in between these two figures, and is thus in the range of inheritance tax collection cost in other countries. Overall, tax collection cost of inheritance taxes are found to be significantly lower than those of annual wealth taxes, primarily because of the lower declaration frequency (once a lifetime vs. once a year) and because some of the administrative processes necessary for the inheritance tax are happening anyway and can thus not be attributed as true tax collection cost of inheritance taxes.  

On top of lower collection cost, inheritance taxes bear another economic efficiency advantage: They are regarded to be less distortive in terms of migratory responses – shifting wealth, residency or nationality to another country with favourable tax conditions – and capital accumulation. Studies found that people usually do not make their working, consumption and saving behaviour dependent on inheritance taxation, nor where they live or hold their assets. Given the currently low effective inheritance tax rates, it is fair to assume this may change to some degree in a situation of substantial/100% inheritance taxes. If you cannot inherit anything of monetary value directly, you might decide to work less, save less, and consume more. At the same time studies have shown bequest motif is only one of the motives, to work and accumulate wealth.  Tax evasion through migration is also increasingly getting difficult due to “exit taxes” and increasing international tax cooperation.

Summary

Inheritance taxes are preferable to wealth taxes from a social liberal perspective due to their ability to address inequality while respecting individual autonomy and minimizing economic distortions. By taxing unearned wealth transfers, inheritance taxes promote intergenerational equity and align with the principle of equal opportunity. They are also more efficient and administratively feasible, avoiding many of the practical challenges associated with taxing wealth annually. With regards to concentration of power, wealth taxes are found to be only an indirect and sometimes ineffective tool. Direct measures, such as stricter regulations on media ownership, lobbying, and political donations, may be the more effective solutions. Wealth taxes, while generally less favourable, can serve as a second-best solution in certain contexts. They may be useful when more targeted taxes, such as inheritance or capital income taxes, or non-tax measures are not yet in place. Additionally, they can act as a tool to address extreme wealth concentration in the short term, targeting living billionaires to mitigate its immediate social and economic consequences. Nonetheless, inheritance taxes remain the superior long-term strategy for achieving fairness and sustainability in a social liberal framework.

Sources & Further Reading