Fortune favours the babes of boomers, and it all comes tax-free​

Widening wealth inequality in Australia provides a compelling reason to consider implementing an inheritance tax.

The Australian

Over the next 30 years, generations X and Y will be showered with the biggest deluge of inherited wealth the world has ever seen. The baby boomers of rich countries, the generation born in the decade or so after 1945, will start to pass on to their grown-up children their property, stocks and cash.

In Australia, at least, none of this will be taxed, but some of it should be. Australia’s tax reform debate is endless but hopelessly narrow, largely confined to the merits of broadening the base or lifting the rate of the GST. A better and fairer reform would be a modest tax on inheritance and offsetting cuts to the marginal rates of income tax.

The baby-boomer generation has become much richer than younger (and older) cohorts of Australians, largely as a result of the massive house price appreciation since the 1980s and historically rapid growth in real wages. Such gains did not stem from entrepreneurial skill or effort but rather the one-off deregulation of the financial system and permanent fall in interest rates. They are unlikely to happen again.

The children of Australians currently aged 55 to 64 could each on average expect inheritances of more than $500,000 were their parents’ wealth divided up now, according to recent work by the Grattan Institute. At the same time, of the 13 per cent of Australians who inherited anything in the decade from 2002, about three quarters received less than $100,000, the same study found. Moreover, Grattan found an unsurprisingly high correlation between the size of an inheritance and the wealth of the recipient.

Some of the boomers’ wealth might be whittled away in their lengthy expected retirements, but probably not much of it thanks to government policy. From a support for the indigent in the early 20th century the age pension in the 21st has become a subsidy to middle and upper-class bequests. Because the principal residence is exempt from the eligibility criteria, older Australians are obviated from having to tap into their significant housing wealth to support themselves, thus ensuring the full value is passed on.

Indeed, NATSEM has estimated that households with net assets above $1 million received cash welfare more than $5.1 billion a year in 2011-12. Mention pensioners and people think of frail, cash-strapped widows in fibro houses. But healthy rich couples in million dollar houses with two cars who holiday annually in Europe (and claim a part-pension from the government) is increasingly the 21st-century reality.

Meanwhile home ownership rates are falling as even high-income workers struggle to get a foothold in the property market. Workers’ real wages are going backwards at the same time as bracket creep inexorably lifts their average income tax rate. Typical workers will soon be paying a 39 per cent marginal tax rate.

Theoretical arguments against estate taxes on the basis they tax savings twice are correct, but the fairness argument trumps it. In any case, levelling a fixed sum of tax on everyone regardless of income, wealth or abilities is the most efficient, yet no one is seriously advocating that. A preference for estate over income tax, say, isn’t the product of some socialist bent but rather basic common sense.

Yet by the jejune standards of current public debate advocates of an inheritance tax would be dismissed as 'left-wing'. This must include John Stuart Mill, one of the 19th century champions of freedom and limited government, who wrote: “I see nothing objectionable in fixing a limit to what anyone may acquire by mere favour of others, without any exercise of his faculties.”

And include also one of the most right-wing economists of the 20th century, James Buchanan, fearsome critic of Keynesian economics, who advocated a 100 per cent inheritance tax. Irving Fisher, one of America’s greatest economists and a leading conservative intellectual of the 1920s, urged the same to combat the “danger of a hereditary plutocracy” to “democratic ideals”. Adam Smith, father of free-market economics, was torn over it: “There is no point more difficult to account for than the right we conceive men to have to dispose of their goods after death,” he wrote.

It is astonishing that in Australia, a country supposedly imbued with 'fair go' values, great and small fortunes routinely pass between generations untaxed while genuine entrepreneurs and workers pay 40-50 per cent of their earnings once GST is factored in.

The best argument against inheritance tax is the difficulty of enforcing in. Britain’s inheritance tax is levied at 40 per cent on assets above £325,000; it applied to only 3 per cent of estates in 2009 and raised less than 1 per cent of revenue. The US taxes estates above $US5.4m and raised a similarly paltry amount. Both versions are riddled with exemptions and levied at far too high a rate.

An inheritance tax of say 10 per cent on fortunes above $1m with no exemptions might be low enough to limit avoidance but high enough to raise significant sums. It would enable income taxes to be lowered, and bolster people’s respect for the democratic, free-market system amid signs of surging wealth inequality within rich countries.

This article was first published in The Australian. Reproduced with permission.