This answer is U.S.-centric, because that is what I know best.
Why Have A Separate Gift And Inheritance Tax Regime?
There are a number of reasons to have a separate tax on donative transfers (gifts, estate, and inheritances) from the ordinary income tax. In the U.S. tax code, gifts and inheritances are exempt from income taxation pursuant to 26 U.S.C. § 102, in order to clear the field for separate gift, estate, and generation skipping transfer taxes.
One big factor is administrative convenience. It is administratively easier for tax officials to monitor the estates of people who die to see if executors and trustees are paying inheritance taxes than it is to see if members of the general public are reporting gifts and inheritances that they receive. In the U.S. system, gift tax returns historically (until quite recently) were usually audited only when someone died further streamlining the process. It also assures consistent valuation supervised by an officially deputized fiduciary chosen for their administrative competence, rather than just an ordinary individual.
Closely related is that fact that the transaction cost frictions associated with sporadic lifetime gifts from individuals interfere with the behavior people would have in the absence of taxation much more than the transaction costs associated with business transactions and employment which are typically systemic, regular, on a scale that creates administrative economies of scale, in transactions that are not "optional" and must be conducted to provide the daily needs of the taxpayer.
The justification for a certain amount of tax free gifts is similar to the income tax standard deduction in the United States that frees a large share of taxpayers from the need to keep detailed records of their daily activities.
A third issue, related to the second, is that there is a fine line between non-taxable expenditures for support of dependents and gifts, which can be better defined in the context of a gift tax. But, any inheritance or estate tax needs to be backstopped by a gift tax to avoid making lifetime gifts a huge loophole to the inheritance or estate tax system. In the case of inheritances to minors or dependent children, this blurring of lines still exists.
A fourth issue is lumping. Inheritance and atypical lifetime gifts often involve amounts that are "earned" over a lifetime, but received all at once, while most kinds of income are received gradually, and those that are not, like capital gains, often receive special treatment to address the "lumping" effect.
Why Use Different Tax Rates?
For the most part, there is no compelling reason to tax inheritances and other income at different rates, and after exemptions, the current U.S. federal estate tax rate and the current maximum federal income tax rate are reasonable similar.
Avoiding Under Taxation Of Capital Gains
One argument in the U.S. context for taxing taxable inheritances at a higher rate than taxable income, as the law did in the early 1990s is that this makes up for a shortfall in income taxation. Many (and probably most) large estate taxable estates derive most of their value from appreciation in a closely held business, appreciation in real estate, and/or appreciation in investments that accrued substantial capital gains during the owner's life that were never taxed. But, due to the "step up in basis of capital gains at death" found in 26 U.S.C. § 1014, these capital gains are never taxed in the income tax system if the owner holds onto them until death. A tax rate on estates that is higher than the tax rate on ordinary income reflects that the estate tax is a combined tax in lieu of income tax on the heirs and a make up tax on capital gains of the decedent that were never taxed in a rough justice sense.
Capital gains from investments in real estate often go untaxed in the U.S. because the capital gain proceeds can be rolled over without triggering taxation into new real estate investments pursuant to 26 U.S.C. § 1031. So, these investments are only taxed when an investor cashes out out the investment real estate sector entirely.
Income from closely held businesses (and even publicly held businesses) is often taken in the form of stock and stock options that are only taxable, again, when they are "cashed out".
And, both stock in a business and investment real estate can be borrowed against in order to avoid triggering capital gains taxation prior to death when the taxes that would otherwise be due on the accrued capital gains are forgiven.
Other countries, like Canada, tax capital gains that have accrued at death, so this isn't a consideration there.
Support v. Gifts
On the other hand, part of the justification, beyond administrative inconvenience, for taxing gifts and inheritances at rates below what would be taxed in the income tax (often zero) is that this reflects the notion that modest inheritances are part of what emotionally amounts to a duty of support which is basically a debt, owed by the older generation to younger generations, just like paying for food, clothing and shelter for children at younger ages.
Historically, the non-taxability of support for children was codified at 26 U.S.C. § 71, but that was repealed when Congress enacted Pub. L. 115-97, Sec. 11051 in 2017 which was fully effective on December 31, 2018 with some transition provisions in the interim. This is now treated as part of the definition of income for income tax purposes pursuant to 26 U.S.C. § 61, by implication since alimony and child support (including child support in kind) are omitted from transactions that constitute income, despite the fact that it is not a comprehensive list of all forms of income, and by 26 U.S.C. § 1041 which excludes from taxation transfers between spouses and transfers incident to a divorce.
Preserving Small Businesses
The tax free inheritance gap also reflects the fact that this can help preserve family farms and businesses, which are seen as socially desirable to continue.
Competing Claims To Inheritances
There is a sense that it makes sense to relieve small inheritances from taxation because they are subject to other claims.
In the U.S. context, there are two main such claimants that have some similarity to inheritance taxes.
First, in the U.S., working class and middle class people are often beneficiaries of the means-tested Medicaid program which while billed as a means-tested grant based program providing nursing home care and medical care to people who can't afford it, actually operates more like a government guaranteed loan. Medicaid keeps track of what it spends on beneficiaries and if they have enough of an estate at death to leave inheritances, Medicaid is a creditor at death with priority over heirs to the extent necessary to repay amounts advanced for nursing home care or medical care to the decedent during life.
Second, many states have costly probate systems in which the courts and executors and their lawyers receive a significant share of the estate, often on percentage of assets fee basis, in order to carry out the process of transferring assets from the decedent to the next generation.
Now, admittedly, these considerations made much more sense when the lifetime exemption from gift and inheritance taxes was $600,000 (about the 70th percentile for decedents when it was in effect due to lack of adjustment for inflation for decades)-$1,500,000 (about the 90th percentile for decedents when it was in effect) per person per lifetime, rather than $12,060,000 (about the 99th percentile for decedents today) per person per lifetime (with unused portions of the exemption inherited for use at a second death by the surviving spouse, as it is in 2022.
Gift And Estate Tax Revenues Are Modest And Wealth Is Concentrated
It is also the case that large donative transfers by gift and/or inheritance involve a much smaller tax base than earned and investment income. As currently constituted, gift and estate taxes provide only about 1% of federal tax revenues in the U.S., and since the people who are subject to the current U.S. estate tax own about 35% of the wealth in the U.S., even if all inheritances were taxed as taxable income, this tax base would still account for less than 3-4% of federal tax revenues if taxed at the roughly the same tax rates as income, while requiring taxes to be paid by about 60 times more people (about 40% of people have so little net worth and so little income that including inheritances in income wouldn't give rise to taxable income even if inheritances were taxed as income).
Reducing the exemption from $12 million per person per lifetime to $1.5 million per person per lifetime would roughly double estate tax revenues from about 1% of U.S. tax revenue to 2% of U.S. tax revenue and would require roughly ten times as many people to file estate tax returns.
Furthermore, the donative transfer tax based in much more concentrated that the income tax base, in a small number of taxpayers, because it turns out that wealth is much more concentrated than income.
Wealth inequality in the USA is even more extreme than income
inequality and – like income -- it has become more unequal over time.
In 1962, the wealthiest 1 percent had 125 times the wealth of a median
household (Mishel et al., 2012, fig 6C). By 2010, this ratio had
ballooned to 288-to-1. Between 1983 and 2010, the top 5% of wealth
holders saw their wealth grow by 83%. The bottom 80% saw their wealth
decline by 3.2% (Mishel et al., 2012)
In 2007, the top 1% of US wealth holders owned 35% of wealth (up from
20% in 1971).
The top 10% (including, of course, the top 1%) owned 73%. The bottom
40% of all US households owned just 4.2% of all wealth. The top 1%
owns 60.6% of financial securities; the richest 10% owns 98.5% of
financial securities, with the “bottom 90%” holding a mere 1.5 percent.
So, the amount of income that can be exempt from income taxes per person without making much of a dent in tax collections and saving the people who are exempt from taxation of lot of administrative hassles for themselves and the government alike, is much smaller, than the value of inheritances that can be exempt from estate taxes per person without making much of a dent in estate tax collections (again avoiding a great deal of administrative hassles for the decedent's estate and the government alike).
A very large share of all inheritances in any given year come from people who have net worths at death in the hundreds of millions of dollars and up, so exempting mere single digit millionaires from estate taxation doesn't reduce estate tax revenues all that much despite reducing the number of estate tax returns that have to be processed and the amount of tax planning for death that middle class and upper middle class people need to pay lawyers and accountants to do, profoundly (easily reducing administrative costs by 90% or more while perhaps reducing estate tax revenues by 10% or less).
The great concentration of wealth allowing a small number of taxed individuals to provide most of the tax revenues from the taxation of gifts and inheritances also figures into the first question of why it doesn't make sense to tax gifts and inheritances as just any other kind of income.
The game of tax policy is to get as much revenue with as few complaints from the people being taxed as possible, and exempting 99% of potential taxpayers while reducing revenues collected from the transfers only modestly serves that practical policy consideration very well.
Some critics of low taxation of inherited wealth attribute this change to "neo-liberal" policy ideologies (see, e.g., Tim Koechlin, "The Rich Get Richer: Neo-liberalism and Soaring Inequality in the United States" at pages 24-29) defined in this way (in footnote 16 at page 24):
Neoliberal “policy makers are committed to free market policies when
they support the interests of big business… But these same policy
makers become far less insistent on free market principles when
invoking such principles might damage big business interests”.
Neoliberalism, so defined, however, does not unequivocally equate with low taxation of inheritances and neoliberalism, unlike anarchism or strict libertarianism, recognizes that some significant level taxation is necessary for a well functioning economy and society.