E LAW - MURDOCH UNIVERSITY ELECTRONIC JOURNAL OF LAW VOLUME 1 NUMBER 4 (DECEMBER 1994) Copyright E Law and/or authors Review of Western Australian State Taxes 1994 Chapter 5 DEATH DUTIES AND OTHER WEALTH TAXES What is a Wealth Tax The Australian Position Types of Wealth Taxes Purpose of Wealth Taxes Validity of Wealth Taxes Conclusion Bibliography WHAT IS WEALTH? Wealth is defined as the net result of assets less liabilities. While recognising the limits of this definition we will not enter into the ontological debate concerning the meaning of wealth. THE AUSTRALIAN POSITION History of demise of death and gift duties Australia no longer has death duties. The beginning of the end was the death of Justice Negus of the Western Australian Supreme court. His brother, Sydney, had the responsibility of getting things in order. He was horrified to learn that even in relatively modest estates, probate duties had a serious impact on property left to a widow.[1] Filled with a sense of outrage he set forth on a crusade to rid the Australians of such a tax. With this as his sole tenet, he was elected to the Federal upper-house as an independent candidate in March of 1970. This was effective in concentrating the minds of mainstream politicians. Pedrick described Queensland in particular as a hotbed of agrarian resentment against death duties.[2] Premier Joh Bjelke Peterson (as he was then) first supported exempting interspousal transfers from gift and death duties. In 1977 he abolished it altogether. This represented a loss to the Queensland treasury of about $25M per year. The other States felt threatened. There was mounting concern about a drain of capital from their state to Queensland. The Commonwealth and the other States followed several years later abolishing their respective death and gift duties. Brief description of State and Commonwealth death and gift duties[3] Until the late 1970s, these taxes were levied on the estate of the deceased by the Commonwealth government and by each of the State governments. The State tax was payable to the State government in which the deceased was domiciled at the time of his death. It was levied on all real and personal property within the State and on personal property located outside of the state.[4] The tax on real property was collected by the State in which it was located. Most States made allowance for tax paid to other States, however this did not apply to the taxes levied by the Commonwealth Government. Each State with the exception of South Australia[5] had a broadly similar tax structure. This structure entailed a progressive rate based on the aggregate value of the estate. There were also concessions made for estates devised to close relatives of the deceased. Each state adopted a different approach to achieve the desired results. The main differences were the exemptions and deductions allowed in (1) the calculation of the dutiable value of an estate; (2) in the definition of the different categories of kinship; and (3) methods of calculating the tax payable. The Commonwealth tax was a relatively simple one. It was levied on the net value of the deceased's estate (except for real property located outside Australia), less a statutory exemption, if applicable, and less State death taxes payable. There was one scale of rates but the amount of tax levied varied according to the State in which the deceased was domiciled. In an attempt to prevent avoidance, the Commonwealth and State governments had legislative provisions for the taxation of gifts inter vivos. Most of these were incorporated into Stamp Duties legislation of the respective states.[6] TYPES OF WEALTH TAXES Wealth taxes can be split into two broad categories: Capital Transfer Taxes (CTT), and Annual Net Worth Taxes (AWT). With CTT, levies are made upon capital which is transferred between the donor and donee, whether this be at death or inter-vivos. By contrast, with an AWT an annual valuation of all the wealth of a tax-payer is made, and this is then taxed. Capital Transfer Taxes The most common type of wealth tax is an estate tax, alternatively known as death duties. This is a tax levied on the entire estate of the deceased and is to be paid by the executors prior to distribution to the beneficiaries.[7] Provided tax avoidance through the use of generation skipping trusts is controlled, this tax will ensure that property is taxed at least once a generation and thus impede large concentrations of wealth.[8] A characteristic of an estate tax is that it is donor as opposed to donee based, that is it taxes the donor on the entire value of the estate being given rather than the donee on the value of property being received. This is an important distinction because if the tax rate is progressive as opposed to flat, then a donor based tax will result in effectively more tax being paid[9]. For example, an estate worth $100,000 is to be divided equally among ten beneficiaries. Under a donor based tax, a tax rate of say 8% may apply to the $100,000, thus resulting in the donor paying $8,000 in tax. Whereas under a donee based tax a rate of only 5% may apply to the $10,000 bequests. Consequently the cumulative amount paid by the beneficiaries would only total $5,000. An alternative to death duties would be to levy an inheritance or accessions tax. This tax would tax the donee and not the donor. It would be more in accord with the ability to pay principle since it would tax each individual beneficiary according to that person's marginal income tax rate, in the case of an inheritance tax, or according to the amount of gifts received over a lifetime, in the case of an accessions tax.[10] These rates could be variable according to the donee's tax rate or the amount of lifetime inheritances. Therefore, the giving of more money to poorer relatives, or the dispersing of an estate more widely is encouraged. Giving large amounts to single persons would effectively result in more tax being paid. The net result is that inequalities in wealth are reduced. One problem with a donee based tax is that it penalises attempts by the donor to compensate parties with special needs who may require a larger share.[11] Both death duties and inheritance taxes could be introduced with a capital transfer or gift tax which would impose a tax on inter vivos dispositions. Such a tax would need to be introduced if the wholesale avoidance of a death tax is to be averted.[12] If the government wished to encourage lifetime rather than death giving, for any one of a number of economic or social reasons, they could achieve this by lowering the rates on inter vivos gifts when compared with death taxes.[13] Annual Net Worth Tax An alternative to a CTT is an AWT, which can be imposed either alone or in conjunction with a CTT. Such taxes would involve an annual valuation of all the wealth held by an individual which would then be taxed on either a flat or progressive rate. This tax, like other wealth taxes, promotes horizontal and vertical equity, but it has substantial administrative costs that are not experienced by CTT.[14] Moreover, an AWT is less likely to consider "capacity to pay". Simply because a person is asset rich does not mean that they can meet their annual wealth tax payment. Whether a CTT or an AWT is favoured, each can be structured to achieve different objectives. For example, a wealth tax designed for horizontal equity would have a low threshold and a progressive rate. Whereas a radical wealth tax designed to reduce inequality might target the very rich and thus have a higher threshold with no ceiling, and progressive rates.[15] One might even choose to combine the two. A wealth tax might contain exemptions for specific types of assets, such as the family home and pensions. These exceptions are necessary to gain political tolerance of such a tax. However, a better alternative is to have a high threshold rather than any specific exemptions. The tax base should be kept general. Allowing specific exemptions will have undesirable social and economic effects; the wealthy will endeavour to find loopholes and adapt their investment habits in line with this.[16] PURPOSES OF WEALTH TAXES Among those OECD countries that have wealth taxes there is a lack of consensus as to their purpose. The most often cited reasons for a wealth tax are revenue raising and taxing according to ability to pay[17]. Another justification for wealth taxes is horizontal equity. Revenue raising Historically, this would seem to be the reason why wealth taxes were first adopted. In Great Britain, the enactment of a progressive estate duty in 1894 was intended as a means of raising revenue. In the US between 1797 and 1902 there were three separate occasions where death taxes were introduced to supplement finance for an impending or actual war. Each time, after the crises had died down these taxes were repealed.[18] At present, it would be difficult to argue that this is the primary reason for such a tax existing in any jurisdiction. The following table shows the contribution death duties and other wealth taxes make as a proportion of total tax revenue. Table 1 YIELD OF ANNUAL PERSONAL NET WEALTH TAXES, 1978, AS PERCENTAGE OF TAX REVENUE AND GDP AT MARKET PRICES[19] Wealth Tax as % of Tax Revenue Wealth Tax as % of GDP Austria 0.58 0.24 Denmark 0.46 0.23 Finland 0.47 0.17 Germany 0.31 0.12 Luxembourg 0.20 0.10 Netherlands 0.59 0.28 Norway 0.66 0.31 Sweden 0.30 0.16 Switzerland 2.77 0.87 Note that with the exception of the Swiss, there is no case where revenue from wealth taxes exceed one percent of tax revenue or half a per cent of GDP.[20] Australia s position, from 1965 to 1975 was quite similar: Chart 1[21] One reason why such taxes make up such a small proportion of total tax revenue is that by definition they have a small base. They are normally targeted at a small proportion of the population. The wealthy. Secondly, since the taxes are meant to reduce large accumulations of wealth, it would make sense that over time, revenues will reduce. Whether this occurs by virtue of effective taxes or more sophisticated avoidance methods is debatable. Vertical Equity Wealth taxes provide a means of redistributing wealth in an equitable fashion according to a person s capacity to pay. They discourage large accumulations of wealth and reduce them. The concept of vertical equity as a justification for wealth taxation has come under fire. The decline in progressive income tax rates over the past decade makes it clear that progressivity itself should be justified rather than merely accepted. Before their abolition in Australia, death duties were levied at a decreasing marginal rate.[22] By definition, a simple flat rate tax cannot fulfil vertical equity. However, the introduction of varying tax rates leads to pragmatic problems. Moreover the addition of exemptions and discounts provide a source of avoidance. This illustrates the general dichotomy between the requirement of simplicity and the other two goals of efficiency and equity. Horizontal Equity Contrast the position of a beggar with no income and a wealthy person with no income. Both would not be liable for income tax, despite the wealthy person s greater capacity to pay. Thus an income tax should be supplemented with a wealth tax to achieve horizontal equity.[23] Wealth taxes reduce the impact of tax avoidance by taxing assets derived from income which has not been disclosed. Moreover wealth taxes target assets derived from exempted income ensuring that income is taxed at least once. But the assumption that all property will be taxed with a wealth tax or death duty is false. Often there are many items such as the family home and personal property which are exempt from tax. This has the effect of creating inefficiencies in the market by redirecting spending. Any exemptions infringe the principle of horizontal equity, particularly for non-income earning assets since wealth taxes exist primarily to tax such assets.[24] Horizontal equity is also defeated if estates are not taxed equally because statutory provisions provide different tax rates based on kinship. VALIDITY OF WEALTH TAXES Social Claims Aside from the collection of revenue, a major principle underlying the rationale for wealth taxes is that of the equal distribution of wealth in order to achieve societal goals of equal opportunity.[25] Interference with property rights at least in the form of progressive taxation is both desirable and in the interests of any society wishing to give meaning to equality and opportunity of goals.[26] In principle this is achieved by concentrating the tax burden upon those who hold the most wealth. However to give the process efficacy, it must be complemented by suitable transfer payments to those in less pecunious sectors of society. This could be achieved by providing inter alia economic security and relief from poverty, through health care and opportunities for higher education etc. Why should the wealthy bear the burden of this pursuit for progressivity? The short answer to this is that they can afford to pay; Estate duty ... represents an `end of term' aggregated net wealth tax: in effect, society taxes the good fortune and stability which enabled the accumulation of property in the first place.[27] A legitimate concern of those subject to wealth taxation is that double taxation results. The property composing an estate would probably have been purchased with income subject to income tax during the deceased's life. However, why not tax the property twice? There is no reason why income tax should be the only tax,[28] for income spent on consumer goods will be subject to various additional taxes such as sales tax and stamp duty.[29] An estate duty does have the attraction that it finally calls to account the tax avoided during a taxpayer's lifetime.[30] In any case, estate taxes whilst raising useful revenue, have clearly not served to eliminate concentrations of wealth. In other OECD countries considerable concentrations of wealth ownership prevail despite the operation of wealth taxes in various forms. In the United States, the top 1% of wealth owners hold about 25% of the country's wealth (half of which is believed to be inherited wealth), which is comparable with the United Kingdom where the top 1% holds about 30% of the country's wealth.[31] Economic Claim In principle, a wealth tax serves to enhance progressive taxation and as such provides a fairer taxation system based upon ability to pay principles for the overall benefit of society. However, opponents of wealth taxation claim that such progressive taxation has a net negative effect when its impact on economic efficiency is considered. They argue that progressive taxation impedes the efficient operation of the market by dampening tax-payer enthusiasm for extra productivity and investment given that such efforts will be taxed at increasingly higher rates.[32] But according to others, progressive taxation (unless severely progressive) will have little or no effect on the work and investment decisions of tax-payers. Indeed the reverse may in fact be true, increased tax rates may cause tax-payers to work harder and invest more in order to recoup the money lost to taxation.[33] There is little evidence to support the view that death duties act as a disincentive to save or invest.[34] In any case any disincentive to the wealth-holder to save and correspondingly to consume his or her income before death is offset by the onus then placed upon potential beneficiaries to save. It was impossible to estimate the final effect on total savings in Australia, as any change to the law would involve psychological effects on tax-payers.[35] The suggestion that aggregate savings and investment would remain unaffected by the imposition of death duties seems the more likely given such duties would be matched by a corresponding decrease in the (progressive) rate of personal income taxation. For high marginal income tax rates have also been cited as creating marginal disincentives to productivity and savings.[36] A wealth tax would have less allocative impact on investment decisions because the tax contingency is considered at death. If, as has been suggested, the possession of wealth discourages entrepreneurship at the macroeconomic level,[37] a tax on wealth may fuel investment effort and incentive. Moreover, death duties may encourage early gifting[38] through legislative provisions allowing for a lesser tax rate for inter vivos transfers. This may benefit the economy overall as it is younger people who tend to be risk-takers. There is the suggestion that, at a macroeconomic level, the imposition of a wealth tax impedes capital formation. However, this ignores the fact that economic growth is not solely derived from the private sector.[39] There is a role for the government through fiscal policy to regulate investment and savings through fiscal policy[40] and to reallocate physical capital in the economy to other equally important areas such as public education[41] or technological advancement. At a microeconomic level, estate duties are criticised for their effect upon family concerns such as small businesses and farms, where assets are generally in a form not easily convertible into the cash.[42] As a result, when such taxes were levied in the past in Australia, it was claimed beneficiaries were forced to sell these concerns to meet the tax liability. At the level of personal hardship the resulting claim for concessions from these groups is tenable. However such concessions serve to distort both horizontal and vertical equity in that preferential treatment is given only to those tax-payers who own the exempted assets.[43] On efficiency grounds such concessions are also undesirable as tax-payers will be encouraged to purchase small businesses and farms to take advantage of tax advantages. The Senate Standing Committee[44] report of 1973 into wealth taxes noted: that in the 30 years prior to its deliberations, the incidence of partnerships in primary production had increased approximately 130% and that the incidence of company involvement had increased 300%.[45] The principle of denying tax exemptions to specific groups is based upon keeping the tax base general in order to allow for efficient market resource allocation. Exemptions tend to protect less efficient managers. Liability to estate taxes may serve to facilitate the more efficient restructuring of these concerns. If property is not being used sufficiently economically to pay off estate or other capital taxes, it should be sold to someone who can make better use of it.[46] If concessions were to be granted to these sectors of the community (for political considerations) they would best take the form, if liquidity is the problem, of simply extending the payment period with provision for interest.[47] Just Rewards Claim This concept involves the ethical notion that those who hold wealth actually deserve it and that tax progressivity is morally wrong.[48] All members of society are entitled to the income they earn and the wealth that they accumulate and accordingly it is the free operation of the market that provides distributive justice.[49] In a sense this argument can be addressed on the criteria of its own capitalist foundations. It is asserted that the generational nature of death duties is necessary for the efficient operation of this market for capital redistribution. The generational aspect of these duties also has a strong claim on conservative philosophy: the belief that wealth is and should be the reward of individual initiative and hard work rests uneasily with the `dead hand' of inherited property.[50] However, this argument is based on the dubious premise that the market rewards people equally in proportion to the skill, effort and ability employed .[51] Clearly an existing accumulation of capital is a launching pad for the accumulation of further wealth. Without this starting capital base, the aspiring wealth-holder must rely solely upon the sale of his or her labour, or debt financing. Moreover, an initial capital holding aids in achieving a higher education which furthers inequality. Arguably, one's socio-economic background is the most important determinant of current or anticipated wealth holdings,[52] with as much as two thirds of capital accumulation being attributable to inheritance.[53] CONCLUSION Wealth taxes in the guise of death duties have been shown to be politically untenable. Whether their justification be revenue raising or to achieve a more equitable society, the overriding unpopularity of such a tax would unlikely to ever see its return. BIBLIOGRAPHY DUFF, DAVID G., Taxing Inherited Wealth: A Philosophical Argument , 6 (1993) Canadian Journal of Law and Jurisprudence 4. [This article provides a comprehensive analysis of the justifications of a wealth tax, taking a comparative analysis spanning various jurisdictions and times across the world.] JOHNS, B.L. and SHEEHAN, W.J. Death and Gift Taxes in Australia in MATHEWS R.L., State and Local Taxation, Australian National University Press and Centre for Research on Federal Financial Relations, Canberra, 1977. [Provides a view of the legislative provisions made by the Commonwealth and the States as well as some statistical analysis of the Australian position.] MALONEY, M. Distributive Justice: That is the Wealth Tax Issue (1988) 20 Ottawa Law Review 599. [This article provided an insight into the justifications for a wealth tax both on a social and economic level. Moreover, it provided us with some assistance as to the types of wealth taxes and common elements within them.] ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, Taxation of Net Wealth, Capital Transfers and Capital Gains of Individuals, OECD, Paris, 1988. [Provides a global statistical and historical background for wealth taxes.] OECD, Revenue Statistics of OECD Member Countries, 1965-1979, OECD, Paris, 1980. [An earlier study, providing view of wealth taxes in context.] PEDRICK, WILLARD, H., Oh! To Die Down Under! Abolition of Death and Gift Duties in Australia , 35 (1981) Tax Lawyer 113. [The author provides a North American perspective. It proves a history of death duties in Australia. In addition it canvases the social and economic claims to justify the operation of a wealth tax. In addition, it provides statistics on the wealth distribution in the USA and the UK.] PIGGOT, J. in "Wealth Taxation for Australia" 6 (1989) Australian Tax Forum 327. [This article helped to provide insight into the characteristics of an ideal wealth tax. In addition, it provides valuable statistical information as to Australia s position re wealth taxes.] RAY, R., The Case for Death Duties, Pamphlet No.40, Victorian Fabian Society, Australia, 1983. [Is largely aimed at the reintroduction of death duties as a means of achieving equity within society. It is written primarily from a socialist stand-point and includes both a historic, political and theoretical appraisal of death duties.] SANDFORD, C. Wealth Tax - European Experience: Lessons For Australia Occasional Paper No. 21, Australian National University, 1981. [This article delves into the issues of horizontal and vertical equity re wealth taxes. Moreover, it gives an appraisal of typical elements found within a wealth tax.] Notes: [1] Pedrick, Willard H., Oh! To Die Down Under! Abolition of Death and Gift Duties in Australia , 35 (1981) Tax Lawyer 113 at 114. [2] Id at 136. [3] See Johns B.L. and Sheehan W.J. Death and Gift Taxes in Australia in Mathews R.L., State and Local Taxation, Australian National University Press and Centre for Research on Federal Financial Relations, Canberra, 1977 at 329-330. [4] This was the general rule prior to the application of exemptions. [5] The duty was payable based on the size of individual inheritances, not the total value of the estate. There were varying rates according to the kinship of the beneficiary to the deceased. See Piggot, J. "Wealth Taxation for Australia" 6 (1989) Australian Tax Forum 327 at 329. [6] For Western Australia it can be found under item 19 of the Second Schedule of the Stamp Act 1921. It should be noted that in Schedule Three has chattels as one class of exemptions. (See North Shore Gas Limited v Commissioner of Stamp Duties (N.S.W.) (1940) 63 CLR 52.) [7] Maloney, M. Distributive Justice: That is the Wealth Tax Issue (1988) 20 Ottawa Law Review 599 at 607. [8] Ibid. [9] Supra n.5. at 336. [10] Supra n.7. at 608. [11] Supra n.5. [12] Supra n.7. at 608. [13] Supra n.5. at 337. [14] Id at 332. [15] Sandford, C. Wealth Tax - European Experience: Lessons For Australia Occasional Paper No. 21, Australian National University, 1981, at 19. [16] Supra n.1. at 136. [17] Organisation for Economic Co-operation and Development, Taxation of Net Wealth, Capital Transfers and Capital Gains of Individuals, OECD, Paris, 1988 at 78. [18] Duff, David G., Taxing Inherited Wealth: A Philosophical Argument , 6 (1993) Canadian Journal of Law and Jurisprudence 4 at 6-8. [19] OECD, Revenue Statistics of OECD Member Countries, 1965-1979, OECD, Paris, 1980. [20] A more recent study in 1988 the OECD found that among the 21 member countries who continued to have taxes on inherited wealth, the percentage of total revenue raised by such taxes in 1985 raged from a low of 0.1% in Norway to a high of 1.19% with Japan, see supra n.17. at p.27 (Table 0.2). [21] Graph derived from data provided in Public Authority Finance: Taxation, 1974-75, Ref. 5.30, Australian Bureau of Statistics, Canberra, 1976 as reproduced by Johns B.L. and Sheehan W.J. supra n.3 at 338. However, it should be noted that the proportions for each State s total tax revenue was significantly higher. They ranged from 6% to 17% in that study. It is suggested that looking at the states would be misleading. One should view it in the context of the whole Australian tax scheme. [22] Id at 333. [23] Sandford, C. Wealth Tax - European Experience: Lessons For Australia Occasional Paper No. 21, Australian National University, 1981 at 3. [24] Supra n.5 at 335. [25] According to Maloney, M. supra n.7. at 612, freedom of testation contradicts the ideal of enhancing equality of opportunity as the unimpeded transfer of wealth allows unjustified inequalities of means and power to be perpetuated within the structure of a society, causing divisiveness and conflict. [26] Supra n.7. at 618. [27] Ray, R., The Case for Death Duties, Pamphlet No.40, Victorian Fabian Society, Australia, 1983 at 20. [28] Id at 10 "No socialist could accept the view that individual property, once past income tax, should be free from further taxation" and at 13 "That it [wealth] should be taxed is a fundamental element of the socialist credo". [29] Id at 13. [30] See Pendrick supra n.1. at 135. See also Ray supra n.27 at 19 "Any non-current income advantage deriving from the ownership of property and assets can be brought within the tax umbrella ... estate and gift duty". [31] Id at 126. It ought to be noted however that these are 1978 estimates but a similar distribution was observed by in 1984 by Piggot, J. supra n.5. at 333 who also indicates statistics for Australia regarding the concentration of wealth are similar i.e. it may be inferred that the existence or non-existence of a wealth tax has little effect on actually altering concentrations of wealth. [32] Supra n.7. at 614. [33] Ibid. [34] A Canadian study into the effects of the 1972 abolition of estate duties concluded that it resulted in a "minimal impact on the rate of saving and capital formation" see supra n.7 at 628. [35] Ray, R. supra n.27. at 10. Maloney, M. supra n.7. at 627 states that "What evidence there is suggests that the relationship of capital formation to economic growth is uncertain at best". [36] See generally Ray, R. supra n.27 at 13, Pedrick supra n.1 at 128 and Maloney supra n.7 at 628. [37] Supra n.7. at 627. [38] Id at 628. [39] Where economic growth is pursued through private capital formation it also needn't be solely large concentrations of private capital. [40] It should be noted that a thorough analysis would incorporate such things as monetary policy and the financial markets. [41] If the tax revenue is used for the further education of low income earners then society benefits overall in that it approaches its full potential productivity as all members of society are able to fully discover and utilise their abilities. [42] Supra n.27 at 9. [43] Supra n.7 at 631. [44] Senate Standing Committee on Finance and Government Operations 1971-1973 Report on Death Duties, Government Publishers, Canberra, 1974. [45] Supra n.27 at 18. [46] Supra n.7 at 632. [47] This was the recommendation of the 1973 Coombs Task Force see Ray supra n.27 at 18 and generally supra n.7 at 631. [48] In ascertaining whether there exists a `moral right' to the ownership of inherited wealth, regard may be had to Rawls in "A Theory of Justice" who wrote "No one deserves his place in the distribution of natural assets any more than he deserves his initial starting place in society": cited in supra n.7 at 617, i.e. if you accept that anyone's initial starting place in society is arbitrary then you cannot claim that one individual has more of a moral claim or is more `deserving'. [49] Supra n.7 at 614. [50] Supra n.27 at 19. [51] Supra n.7 at 614. [52] Id at 615-6. [53] Supra n.5 at 333.