What arguments are typically offered by those supportive of this
taxation technique, both ethically and economically, in order to
defend and promote its use?
Inheritance Taxes As Taxes In Lieu of Income Taxes
Inheritance taxes aren't taxes on dead people who paid taxes on what they earned during life. The dead people are dead. They suffer no harm and receive no benefit from what happens to their wealth after their deaths. An inheritance tax, even when structured as an estate tax, is fundamentally a tax on people who receive inherited wealth upon which they have paid no taxes.
As a general rule, we tax increases in wealth that result from transfers of money and property. At a very basic level, a bonus to an employee of $1,000,000, winning $1,000,000 in the lottery, receiving a gift of $1,000,000 and receiving an inheritance of $1,000,000 are all events with the same economic effect on the recipient and fit within a broad definition of income.
But, in most countries, gifts and inheritances are exempt from taxation as income and a gift or inheritance or estate tax is a tax in lieu of an income tax that is designed to impose less of an administrative burden than treating gifts and inheritances as income would.
Generally speaking, we tax individuals as individuals, not as corporate family units.
Not subjecting gifts and inheritances to income taxation is the exception to the general rule, not imposing taxes on large gifts and inheritances.
Thus, an inheritance tax can be seen as a way of broadening the income tax base, particularly if those taxes would be comparable in magnitude for similar amounts of property transferred. In this view, an inheritance tax supports the standard economic maxim that if you want to raise a certain sum of money, and you have to use distortive taxation, it is best (in terms of efficiency) to use all margins, i.e. to distort everywhere a little instead of only somewhere a lot. Expanding the tax base to include taxation of inheritances, could allow income tax marginal rates to be somewhat lower, and improve efficiency.
Recall also that income and inheritance taxation are fundamentally, in principle, justified as you are paying for the benefits you receive from the government's efforts to create a system of laws and a regulated society. Income and inheritance taxes are ethical to impose because they are paying the taxpayer's fair share of benefit received from living in that society which is orderly/safe enough that you were able to give/gain that wealth by means of income or inheritance at all.
What Did Heirs Do To Deserve This?
Indeed, ethically, there is less justification for taxing earned income, for which the recipient had to give up something of value in time and effort in order to get paid, than there is for taxing a lottery winner, gift recipient, or inheritance recipient who gave up little or nothing to earn the money received and did absolutely nothing of substance to deserve this wealth. Why not tax undeserved money?
The Economics Of The Leisure Class
Put another way, inherited wealth creates a leisure class that we do not need and who are mere parasites on society that don't have to contribute anything to it.
Of course, sometimes people who inherit wealth do develop noblesse oblige or utilize their leisure to make long term progress for society in science and culture that people forced to think about providing for themselves economically, which is pretty much everyone who does not inherit great wealth, don't have the resources of time or money to do.
Dumb Money Doesn't Manage Wealth Well
This ethical consideration ties into an economic one. Someone who earns a lot of money can generally be trusted to be competent to manage and invest it well, but we have no similar assurances that the recipient of the property will be particularly qualified to manage it in the case of "dumb money" received by lottery or accident of birth.
This doesn't mean that heirs to great fortunes die paupers. But, for example, if Donald Trump had simply invested his inherited wealth in an S&P 500 Index fund instead of actively managing it, he would be more wealthy than he is today.
But, Heirs Might Be Better Than Average Property Managers
On the other hand, the children of wealthy people or objects of the bounty of wealthy people may be more qualified than the average person to manage that wealth, due perhaps to inherited aptitude, or perhaps because they have been groomed for that responsibility during life.
But, this is undermined by the fact that most inherited wealth dissipates in subsequent generations, rather than building up. People who inherit wealth are more likely than people who accumulate wealth themselves to use it for self-indulgence or to lose it with bad investments. Great fortunes rarely last even three or four generations.
Economics is all about incentives. The incentives created by an inheritance tax or its absence, are complex and lead to considerations that run both ways.
The Economy Needs An Incentive For People Who Can't Take It With Them
One reason that we don't tax gifts and inheritances at a 100% rate is because the ability to pass on wealth to the next generation gives the people who are currently earning that wealth an incentive to create more wealth and because these very wealthy people would be less economically productive if they couldn't do so.
But, the empirical account here is also mixed.
First people earn money for their own comfort, but in the low tens of millions of dollar range and up, most people who earn great wealth struggle to spend it as fast as they earn it, because at that point many of the things that they purchase (e.g. real estate and art) don't get used up and decline in value after you buy them.
Then, up to a point, people want to leave everything they own to their children.
But, at some point, the vast majority of wealthy people (for whom I've worked as an estate planner for most of my adult life) start to think that enough is enough and no longer want to spoil their children (who are themselves typically past retirement age when they receive inheritances in this day and age). After that point (in reality this starts to kick in around the tens of millions of dollars mark), the very wealthy tend to be more concerned about leaving a legacy for the larger community in the form of university buildings and museums named after them, charitable foundations and other symbols of them having made a difference in the world, and those charitable gifts and inheritances are typically not taxed.
It is certainly not the case empirically that even a 45% gift and inheritance tax rate significantly reduces economic productivity in people who give their wealth to family members. You really need to approach 60%-70% effective rates or so before you start to see much of a significant impact on productivity of donors, and that is only in cases where charitable legacies are not a primary concern.
Nudging The Rich To Do Good Rather Than Merely Doing Well
Normal decent people, even really rich ones, want to benefit both family and friends and a larger society. Normally, in the absence of a nudge from society, they err on the side of giving to family rather than society as their motivating goal to continue producing. But, inheritance taxes provide a nudge that helps the wealth shift their preferences modestly from a basically selfish motivation to a more community oriented motivation, by making charitable gifts and inheritances tax free, while taxing gifts and inheritances to family and friends.
This makes inheritance taxes basically optional. You can give to society and not pay these taxes and have a choice over what cause in society you want to promote. This choice of which cause you want to promote still gives you an incentive to work productively in old age to advance that societal goal. And, the earners unlike their heirs, have shown themselves to be high in merit and so likely to make good and efficient choices about how to improve society with their estates. And, while the causes chosen by wealthy old people to advance may not exactly match societal needs, tax funds can fill the gaps that no one wealthy was interested in donating to at death, so it doesn't really matter all that much exactly what charitable legacies the rich leave, even though they and their heirs can feel good about the charitable legacies that they do leave.
Not An Incentive For Heirs
The flip side of the incentive that is provided for donors is that inheritance provides no incentive whatsoever for heirs to do anything but engage in self-indulgence that has no necessary benefit to the larger society. Huge amounts of resources that could have been used to create incentives are instead squandered away without receiving anything in return. Indeed, the empirical evidence clearly supports the conclusion that people who receive "economic life support" in the form of substantial gifts and inheritance become much less economically productive than comparable individuals who do not receive substantial gifts and inheritances.
Most of the time, spending money boosts the economy more than sitting on it, and purchasing productive investments creates more value than purchasing unproductive investments. But, people who receive inherited wealth are much more likely to not spend and to not productively invest their inheritances, than the people who would have received that economic benefit had the money been taxed and distributed. So, untaxed inheritances are a drag on the economy.
Inheritors of wealth buy paintings and fancy mansions, not backhoes and factories. They invest in prestige rather than infrastructure.
Their spending reduces the economy's capacity to produce necessities in favor of its capacity to produce luxuries that most people can't afford at all.
Economies of Scale
Historically, one of the important reasons to not only allow inheritances but to specifically favor inheritances to a single heir to an entire fortune was that gifts and inheritances were a major mechanism by which significant amounts of property were concentrated under a single manager, which allowed for economies of scale.
Someone with a 10,000 acre estate can engage in agricultural strategies that benefit from economies of scale in a way that a yeoman with 40 acres and a mule cannot.
But, the importance of the economy of scale justification for inheritance greatly declined when institutions like trusts and corporations made it possible to consolidate management of large quantities of assets without giving all of the benefit of those assets to the person managing them. You can equitably divide shares in a corporation causing the wealth associated with the corporation to be equitably divided, without giving shareholders a meaningful say in anything other than deciding which single CEO will be appointed to run the company when the current CEO is unwilling or unable to act.
Inequality, Meritocracy And Incentives For Everyone Else
Excessive Inequality Encourages Have Nots To Be Unproductive Too
Inheritances meaningfully increase economic inequality between families and between classes of people. The recipients of inheritances often receive great wealth that someone else would be more qualified to manage. And every time you reward someone in the economy for the accident of their birth, you are simultaneously not providing an incentive for someone who has economic merit. (If someone has both very lucky birth and extreme merit, they don't need an inheritance to be wealthy themselves based on merit, so the net benefit to the economy from inheritances received by that person are modest.)
Basically, inheritances push us towards a winner take all economy in which lots of people who would be highly rewarded in a fully meritocratic society are undercompensated and may decline to fully utilize their abilities knowing that fact.
Economic Harms Are Caused By Excessive Rent Seeking Due To Inequality
Winner take all economies divert effort of highly able people from producing economic value that increases the size of the pie for everyone, to "rent seeking" which decides who gets the existing bounty without contributing to the total amount of wealth in the economy.
Rent seeking involves significant expenses that are dead weight loss to society. Frequently rent seeking costs in a conflict by all parties to a conflict can equal or exceed the economic rent that is at stake (e.g. the aggregate litigation costs of parties in a lawsuit over who owns an income producing asset).
In addition, economic rent seeking diverts resources from more productive economic activity.
Now, if you live in a society whose wealth primarily derives from rents and income from the ownership of property, and individual efforts to engage in creating new wealth are fairly insignificant in the overall picture of the society's economy (e.g. Saudi Arabia or Medieval France), having an economy that revolves largely around rent seeking and privileges inherited wealth isn't a serious problem for the society.
But, if economic rents are a pretty small share of the society's total wealth and economic production, then favoring rent seeking behavior in a winner take all economy that ends up that way through the great importance of inherited wealth, at the relative expense of people who have merit and generate new wealth through their own efforts, is a catastrophe.
Dead Weight Losses Arise Due To Gatekeeping Expenses
Another problem with high levels of economic inequality is that lots of resources have to be devoted to gatekeeping and guarding the wealth of the wealthy from those denied wealth, which isn't necessary to nearly the same degree in more egalitarian societies. This expenditure is basically wasted economic capacity.
Inequality Creates A Risk Of Revolutions And Excessive Dissent
And, if inheritance becomes too important relative to earning income, eventually your very political system becomes unstable and the poor meritocrats will revolt and depose the dumb money.
This isn't just an abstract possibility.
We think of the late 1940s to early 1960s as a time of national tranquility and prosperity in the U.S., but the truth is that it was an incredibly turbulent time in terms of domestic labor unrest.
One of the reasons that the U.S. has one of the tamest labor forces and weakest unions in the developed world after unfathomably intense labor actions from the late 1940s to the early 1960s, is that colleges and universities shifted to meritocratic admissions, expanded higher educational capacity, and financed higher education through the GI Bill and public colleges, so that people who didn't have great wealth could advance to their full meritocratic potential.
People who were shut out of the upper middle class until then and became union leaders instead, were coopted into the establishment based upon their abilities and the content of their character. Anti-discrimination laws also cut down these barriers, and taxes in this period for the wealthy were very high indeed, including inheritance taxes.
As wealth inequality limits the ability of talented people with little inherited wealth to succeed again, those people will devote themselves to undermining the system rather than being coopted by it and advancing it.
The "Let Them Eat Cake" Dilemma
Finally, from a primarily ethical perspective, with great wealth comes great responsibility and this maxim applies at a societal level as well as an individual level.
In a society that has vast wealth sufficient to eliminate the suffering and privation of the poor, allowing people who were lucky enough to be born rich to have vast wealth while redistributing none of this unearned societal wealth to those who profoundly need it, is inherently unethical and unjust.
An inheritance tax takes from people who have done nothing to deserve wealth and don't need it, and gives it to people who direly need it or to other worthy societal goals.
Imposing Some Taxes On Unrealized Capital Gains
Another key point to realize in the particular case of the United States is that lots of wealth of most wealthy people takes the form of capital gains, i.e. appreciation in the value of property like real estate and business stock, that has never been subject to any income taxation. Under U.S. tax law, all accrued capital gains in property owned at death are tax free. So, but for an inheritance tax, all of those capital gains (which clearly meet the definition of income) are never taxed at all to anyone. Thus, in the U.S. tax system, an inheritance tax ensures the unrealized capital gains of people who die are taxed at least once. Death is a natural time to do this, because a transfer of the asset must take place anyway at this point.
The ability to totally escape capital gains by holding onto assets also discourages people from selling assets when, but for taxes, that would be the economically efficient choice.
Also, the prospect of inheritance taxation prevents economic resources from being skewed too far towards capital gain producing activities and away from income producing activities. For example, without an inheritance tax, more resources would shift to zero sum real estate investments that rely on appreciation in real estate values and away from retailing and manufacturing and construction sectors that generate current income more than capital gains.
Canada, in contrast, for example, treats death as a deemed sale of capital assets to the inheritors under its income tax, which makes an inheritance tax somewhat less important for revenue protection purposes.