Death Taxes and the Concentration of Wealth

A document from the CQ Researcher archives:

Report Outline
Federal Government's Need of Additional Revenue
Increasing Concentration of Wealth
Use of Inheritance Taxes to Break Up Big Fortunes
Federal Taxation of Estates
State Taxation of Inheritances
Revenue from Federal and State Death Taxes
Special Focus

Federal Government's Need of Additional Revenue

Tax Plane Advanced by Administration Rpublicane

The accumulating deficit of the federal government for the fiscal year 1932 stood at $463,171,554 on September 15, 1931. The deficit on the same date last year was $313,797,335, and the fiscal year ended with a total deficit of $902,716,845. If this year's deficit accumulates at the same rate as last year's, the fiscal year 1932 will end with a new deficit of $1,332,429,301.

The continuation through the first quarter of the present fiscal year of the downward trend in federal revenues, in the face of mounting expenditures, has diminished the hope that increases in taxation at the next session of Congress may be avoided. Demands for fresh appropriations for relief during the coming winter promise to enhance the Treasury's difficulties, and Secretary Mellon is said to have in preparation a measure which would increase the Government's revenues by reducing income tax exemptions and restoring some of the excise taxes that were repealed in 1926. Meanwhile two other plans have been advanced by administration Republicans for consideration when Congress meets. Senator Reed (Pa.), a member of the Senate Finance Committee, would impose a general sales tax of one-half of one per cent; would repeal the capital gain and loss provision of the present income tax; and would increase estate taxes. Rep. Bacharach (N. J.), a member of the House Ways and Means Committee, would increase surtax rates on incomes between $100,000 and $1,000,000; would levy excise taxes upon luxuries and nonessentials; would increase estate taxes; and would reimpose an outright gift tax to prevent evasion of the taxes on estates.1 Whereas Secretary Mellon has advocated repeal of the federal estate tax, the Reed and Bacharach plans both propose increases in that tax.

Demands for Heavier Taxation of the Rich

Republican insurgents, who hold the balance of power in both houses of the new Congress, prefer the Bacharach plan to the proposals of Senator Reed or the ideas of Secretary Mellon. Bacharach conies very near, indeed, to stealing their own thunder. In a statement of September 10, 1931, he said:

In view of the fact that the government has placed no substantial limitation on the accumulation of wealth, and because in recent prosperous years the relatively new taxpayers with net incomes in excess of $100,000 have actually accumulated extraordinary amounts of capital, it seems obvious that those individuals are able to bear and should bear the bulk of any increased burden.

Senator Reed thought, on the other hand, that a policy of “soak-the-rich” would drive capital into hiding. Heretofore proposals for increased taxation of the rich have come almost exclusively from members of the insurgent group in Congress, or from organizations classed as “liberal” or “radical.”

The Labor Day Message of the Federal Council of Churches, read in thousands of Protestant churches on Sunday, September 5, asked prayers for the jobless and pointed to the evidence of the income tax returns as showing an increasing concentration of wealth.

Such a distribution of wealth and income concentrates wealth largely in the hands of a few, while it leaves the masses of workers with insufficient income to buy goods which …they are now able to produce. …That there are grave imperfections in an economic order which makes possible the stark contrast of vast fortunes and breadlines is obvious. Society must turn its attention increasingly to the unsoundness of the present distribution of the national income and to the control of the money-making spirit which lies behind it.

The League for Independent Political Action, headed by John Dewey, called upon President Hoover, in a letter September 6, to summon a special session of Congress to deal with unemployment. The issue, it said, was clear: “No one in this crisis should have cake until everyone has bread. Higher income and inheritance taxes on wealth in the higher brackets will provide the funds.”

Rep. LaGuardia, a leader of the insurgent Republicans in the House, said at New York, September 5, that increases in taxes at the next session were inevitable. “Increases on income taxes in the higher brackets and increases as high as the English rates in inheritance taxes. …will surely be part of the fiscal program of the next Congress.” Whereas the Republican insurgents favor heavier taxation of the rich as a permanent policy, Rep. Bacharach said all the taxes he proposed could be repealed if “prosperity returns quickly, as we all sincerely hope.” It would be better, he said, for the Congress meeting in December to adopt a “timely program with reasonable rates than to delay until the situation becomes more desperate and the door is open to more radical legislation with unreasonable rates.”

Federal Vs. State Taxation of Inheritances

Twenty-five years ago, in his annual message to Congress in December, 1906, President Roosevelt advocated heavy taxation of inheritance, not as a revenue measure, but with the primary object of putting “a constantly increasing burden on the inheritance of those swollen fortunes which it is certainly of no benefit to this country to perpetuate.” In 1913 Senator Norris, offering an inheritance tax amendment to the Underwood tariff bill, urged upon the Senate the social justice of breaking up large accumulations of wealth in the hands of individuals. On the whole, however, both federal and state statutes for taxation of estates and inheritances have been framed as revenue measures. With the exception of the present law, this form of taxation has been used by the federal government only in time of war emergency, the previous acts having been repealed when the need for increased revenues had passed.

Taxation of inheritances has been widely regarded as a state, rather than a federal, function, since legacies and bequests are transmitted under state laws. The revenue derived from such taxes, moreover, has been relatively a more important part of total state revenues than of the total federal revenue. But since amendment of the federal law in 1926 to grant a credit of 80 per cent on account of inheritance taxes paid to the states, the federal sand state systems of inheritance taxation have become intimately related, and the federal tax has become more firmly fixed as a permanent part of the national revenue structure.

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Increasing Concentration of Wealth

The Increase in Large Income, 1921–1929

Senator borah said in an address at the Progressive Conference at Washington March 11, 1931, that four per cent of the American people owned 80 per cent of the country's wealth, but he did not explain the basis of that conclusion. Determination of the proportions in which the wealth of the country is held is at best a matter of broad estimate. The most that can be said is that there appears to be a trend towards increasing concentration of wealth in the hands of relatively few persons.

The Treasury Department's analysis of income tax returns constitutes virtually the only source from which exact figures on a comprehensive scale can be obtained. At the same time, the 4,000,000 persons who file income tax returns represent only a small proportion of those who receive income, and even the facts revealed by the income tax returns do not always present an entirely accurate picture of the distribution of wealth in that group of the population. They may be relied upon, however, to indicate general tendencies.

Increase of Large Incomes, 1921–1929

There has been a striking increase in the number of large incomes since the depression of 1921. The latest statistics available are the preliminary figures on incomes received during the calendar year 1929. The stock market collapse, which occurred near the end of that year, produced the first check to an otherwise steady growth in the number of incomes above $100,000.

The growth in large incomes has been cited as proof of rapidly increasing concentration of wealth. It is undoubtedly evidence of a trend in that direction, but it is subject to the qualification that the income tax records for years prior to 1925 probably failed to indicate the true extent of large aggregations of wealth then existing. It seems clear that the high surtaxes in effect at that time brought about resort to tax-exempt securities and other means of tax avoidance by the wealthy on a much more extensive scale than has been the case since modification of the income tax rates. Rep. Bacharach pointed out in his statement of September 10, however, that there had been an increase of more than 5,000 in the number of taxpayers with incomes over $100,000 since 1925, and drew the conclusion that “the rich are getting richer and the poor poorer.”

The only class which reaped substantial profits during the years 1925 to 1929 [he said] consisted of about 14,700 individuals with net income in excess of $100,000 per annum. This class increased their investment income and probably their capital by more than 50 per cent; the other classes lost ground.

Income of the “Richest One Per Cent”

According to a study made by Harold Brayman, the richest one per cent of the taxpayers in 1921 had 13.16 per cent of the total reported income, while the same percentage of taxpayers in 1928 had 25.02 per cent of the income, the figure falling to 24.27 per cent in 1929. The top one per cent in 1921 extended down to individuals with incomes of $20,000, while in 1928 and 1929 it comprised only those with incomes of $50,000 or more. This group included 20,000 fewer persons in 1928 than in 1921, but during that period it had received more than three-fifths of the total increase in all reported income.2

Changes made by the Revenue Act of 1924 should be borne in mind in considering the above table. That act not only lowered surtax rates, but by raising the amounts of personal exemption, it reduced by more than 2,000,000 the number of persons required to file income tax returns. This partly accounts for the percentage changes above. The table nevertheless indicates a substantial increase in concentration of wealth. This is particularly evident from the fact that $2,000,000,000 of the $2,680,000,000 increase in all incomes in 1928 over 1927 was reported by individuals with incomes in excess of $50,000. These were years in which there was no change in tax rates.

A survey by the Federal Trade Commission gives the record of estates in 24 counties in 13 states, covering the years 1912 to 1923. During this period there were 43,512 probated estates with an average value of $15,428 and an aggregate value of $671,322,676. The estimated number of unprobated estates was 141,446, with an estimated average value of $258 and a total aggregate value of $36,493,068. About one per cent of the estimated number of decedents owned about 59 per cent of the estimated wealth, and 13 per cent owned more than 90 per cent of the wealth. The average value for all estates was $3,800, but the estates of more than 91 per cent of the decedents fell below that average.3

Effect of Equalizing Incomes

Willford I. King, of the National Bureau of Economic Research, found in a study of the distribution of the national income that the percentage of income recipients having incomes under $5,000 remained about the same from 1914 to 1921 and had since been growing smaller; correspondingly, the share of the total income going to that class has been declining since 1921. According to his study, the percentage of the entire realized income received by those having incomes above $25,000 was slightly higher in 1926 than in 1914 but was not as large as it had been in 1915. He detected a slight tendency toward a concentration both of numbers of persons and of income in the class having incomes between $5,000 and $25,000.4 His figures are all adjusted to dollars of 1913 purchasing power.

Dr. King's studies indicate that the mass of people in the class having incomes below $5,000 received in 1926 approximately seven-eighths of the entire realized income of the nation, while the few with incomes in excess of $150,000 ($249,255 in 1926 dollars) had only one-sixtieth of the total income. If all persons with incomes in excess of $5,000 ($8,309 in 1926 dollars) had been allowed to retain $8,309 each and the remainder of their income had been distributed proportionately among the members of the lowest income group, the average income in that group would have been increased by only one-eleventh. This change would have been less than that brought about by increases in the productiveness of the country's industry between 1922 and 1926.5

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Use of Inheritance Taxes to Break Up Big Fortunes

Inheritance Taxes for Revenue Only

There are two schools of thought on the proper function of inheritance taxation, and equally eminent opinion, both economic and political, can be found to support the theories of each. On the one hand are those who hold that taxation of estates and inheritances should be for revenue only, and that the tax, being a levy on capital, should be used sparingly, lest the capital of the nation be dissipated in current expenditures and tax resources be unduly reduced. On the other hand are those who believe that large fortunes are a menace to the country and should not be allowed to accumulate unchecked. They hold that wealth should bear a heavier proportion of the tax burden, and that the inheritance tax may justly be used as an instrument to carry out social and economic theories. In general, it is the conservative elements of the population which subscribe to the former view, while liberals and progressives adhere to the latter.

The problem has been stated by Harley L. Lutz, professor of economics at Leland Stanford University, as follows:

It is true that the inequality of wealth and incomes is one of the most serious aspects of the system of private properly, and …one of the least defensible. Many persons have been inclined to view with favor the possible by-product in the way of lessened inequality which might be secured through the application of steeply graduated taxes on accumulated wealth. Alluring as this prospect may be, we must not overlook certain complication? which inevitably arise as we begin to emphasize this use of taxation. To the problem of a wise selection of the evils to be combated or the reforms to be introduced through the increase or diminution of taxes must be added those that would arise as the state appropriated and undertook to manage large masses of property. There would be great temptation to dissipate the wealth thus obtained in ways that would produce, at best, only a transient benefit for the poorer classes, and this temptation would be the more difficult to resist because the means at hand had been obtained by heavy taxation of a lew. The possible check to accumulation and the growth of the country's capital would also need to be carefully considered. …

We may accept with composure the indirect effects of reasonable inheritance taxation, imposed primarily with a view to securing revenue and adjusted according to the principle of ability. Projects for extremely heavy inheritance taxation for the avowed purpose of checking large accumulations, “reducing swollen fortunes,” and remedying social ills generally, deserve rigorous analysis of ultimate effects and consequences before being accepted.6

Charles J. Bullock, professor of economics at Harvard, believes that heavy inheritance taxes in the long run are neither financially profitable nor economically sound. In an address at the National Conference on Inheritance and Estate Taxation at Washington in February, 1925, he said that “such a policy of fiscal spoliation” could not be shown ever to have allayed social unrest.

Unlike Presidents Roosevelt, Taft, and Wilson, President Coolidge was opposed to federal occupation of the field of inheritance taxation. He particularly disliked use of the tax as a social weapon. “I do not believe,” he said in an address at the Conference on Inheritance and Estate Taxation, “that the government should seek social legislation in the guise of taxation.”

We should approach the questions directly, where the arguments for and against the proposed legislation may be clearly presented and universally understood. If we are to adopt socialism, it should be presented to the people of this country as socialism, and not under the guise of a law to collect revenue. I do not, feel that large fortunes properly managed fire necessarily a menace to our institutions and therefore ought to be destroyed. On the contrary, they have been and can be of great value for our development.

Secretary Mellon asked the Senate Finance Committee in April, 1924, to cast aside “any question of the (estate) tax as a means of punishing wealth or as in some way for the social good of our civilization.”

The social necessity of breaking up large fortunes in this country does not exist. Very wisely our forefathers declined to implant on this continent the principle of primogeniture, under which the eldest son alone inherited and properties were kept intact. Under our American law it is customary for estates to be divided equally among the children, and in a few generations any single large fortune is split into many moderate inheritances, and the continuation through generations of a single fortune has been proved to be impossible.

To the argument that taxation of inheritances constitutes a levy on capital it has been replied that even a fairly heavy tax can be liquidated through annual payments from the income of the estate if sufficient time is allowed. The danger lies in cases where the law requires an early closing of the estate. This may mean forced sale of capital assets to provide cash with which to meet taxes. It must be admitted that the moderate yield of death taxes in this country, in comparison with the total wealth and total income, scarcely indicates that the present burden constitutes a serious threat to the nation's capital resources.

The estate of Harry Payne Whitney, valued at $186,579,746 at the time of his death in 1927, paid total death taxes to the federal government and the states of $22,179,274, or only 12 per cent of the total value of the estate. Between 1927 and 1929, the value of the estate increased by $52,721,270, or nearly two and a half times the amount required to pay the death duties levied upon it.

The Demand for Higher Death Taxes

A demand for graduated taxation of inheritances appeared in the platform of the Socialist-party as early as 1892. It was advocated by the Roosevelt Progressives in 1912 “as a national means of equalizing the obligations of holders of property to government,” In his inaugural address President Taft recommended a graduated inheritance tax “as correct in principle and as certain and easy of collection.” President Wilson, in his message to the extra session of the Sixty-Sixth Congress May 20, 1919, suggested reconsideration of the estate tax in its relation to the fiscal systems of the states but declared that “it certainly ought. to remain a permanent part of the fiscal system of the federal government.”

At the Conference on Inheritance and Estate Taxation in 1925, Professor Seligman of Columbia proposed establishment of a single federal tax, combining the elements of both an estate and an inheritance tax, a portion of the revenue to be distributed among the states. He pointed out that in England the social income is only about one-third that of the United States, while the proceeds of the tax are very much greater. He contended that if defects in our law and its administration were remedied and rates imposed as high as those in Great Britain, the tax would yield annually some $700,000,000 or $800,000,000.7

Senator Couzens (R., Mich), a member of the Senate Finance Committee, said, April 25, 1931, that he favored reinstatement by the next Congress of the 1924 maximum surtax of 40 per cent on incomes, imposition of a graduated gift tax, and institution of an inheritance tax to replace the present federal estate tax. Himself a wealthy man, he said that federal taxes on the wealthy were not onerous. Rep. Ramseyer (R., Iowa), a member of the House Ways and Means Committee, has advocated increases in the estate tax and imposition of a gift-tax as measures to make up the deficit.

The estate tax [he said] is a just tax and does not in the least stifle enterprise, initiative, and accumulation of wealth. The objects of estate and inheritance taxes are, first, to prevent the accumulation of wealth in the hands of those who contribute nothing or little to its creation, and, second, to lighten the burdens of taxation weighing so heavily on the backs of the masses.

In an address before the Tennessee General Assembly, June 11, 1931, President Green of the American Federation of Labor urged changes in inheritance tax laws “so that huge fortunes may be so taxed as to bring about a distribution of these huge fortunes through the instrumentality of the law.” Another spokesman of the Federation of Labor has said that “what labor fears is that taxes will be gradually taken off of the well-to-do and finally placed through a consumption tax upon those least able to bear them.” President Green later opposed the Reed plan for a sales tax as a step to this end.

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Federal Taxation of Estates

Three federal inheritance tax laws, all distinctly of an emergency nature, preceded the present statute. In anticipation of war with France in 1797, a law was passed imposing a stamp tax on legacies of personal property exceeding $50. This was in effect from 1798 to 1802. A legacy tax and a probate duty were provided in the revenue act of July 1, 1862. They yielded about $1,500,000 annually. The levies were repealed in 1870. The third law was enacted in 1898, and imposed inheritance taxes graduated in accordance with the amount of the bequests and the relationship of the heirs. This act, yielding about $5,000,000, was repealed in 1902.

Federal taxation of inheritances on a permanent basis was contemplated in 1894. The income tax law of that year, later declared unconstitutional, provided for the taxation of inheritances as income. In 1909 an inheritance tax amendment to the Payne tariff bill was approved by the House. In the Senate an income tax amendment was also proposed, but by compromise both amendments were removed from the bill, with the understanding that an amendment to the Constitution specifically authorizing federal taxation of incomes would be initiated.

The act of 1916 and succeeding acts have provided for an estate, rather than an inheritance, tax; that is, the tax is levied upon the estate as a whole and is therefore graduated only as to amount of the total estate. This method is simpler and provides a greater yield, since it is not necessary to grant an exemption to each beneficiary. The act of 1916 allowed an exemption of $50,000 on each estate. The rates were graduated from one per cent on the first $50,000 in excess of the exemption to 10 per cent on amounts over $5,000,000.

Estate tax rates were advanced twice in 1917, the minimum rate finally being set at 2 per cent and the maximum at 25 per cent on amounts exceeding $10,000,000. Just after the close of the war the rates in the lower brackets were cut, but those in the upper range were left at the 1917 level. In 1924 estate tax rates, instead of being reduced, were raised to a maximum of 40 per cent, the increases starting at the $100,000 bracket. At this time a credit not to exceed 25 per cent of the federal tax was allowed for inheritance levies paid to the states. A gift tax was included for the purpose of checking evasion of the estate tax. Its rates were identical with those of the estate tax.

Movement for Repeal of the Federal Estate Tax

Agitation for repeal of the federal estate tax and for reform of inheritance taxation by the states became active at about this time. The state laws were then far from uniform, and many estates were subjected to taxation by several jurisdictions, the overlapping reaching confiscatory proportions in some instances.

Secretary Mellon in his first annual report had opposed high estate taxes and urged reduction of the then maximum rate of 25 per cent. In a statement before the Ways and Means Committee October 19, 1925, repeal of the federal tax was definitely advocated. The Secretary declared that the tax belonged to the states and not to the federal government, that it should be reserved as a source of emergency federal revenue, that it contributed largely to the “present muddle of death taxes,” and that it reduced the values which the states badly needed for taxation.

National conferences on inheritance and estate taxation were held in Washington and New Orleans in the course of the year 1925 under the auspices of the National Tax Association. At the latter meeting a report was adopted recommending repeal of the federal tax at the next session of Congress, such repeal to become effective six years later. It was proposed that in the meantime the high rates be reduced and the 25 per cent state credit raised to 80 per cent. The states were thus to have opportunity and inducement to promote uniformity of their laws and to further the movement for reciprocity whereby the evils of multiple taxation were being largely eliminated.

Estate Tax Law of February 26, 1926

With the exception of the proposal for repeal, the recommendations of the New Orleans conference were largely embodied in the estate tax provisions of the 1926 law. The Senate, in fact, did vote to repeal the tax, but it was restored in conference with the House. As finally passed, the act substantially reduced the estate tax, the rates being more slowly graduated from a minimum of one per cent to a maximum of 20 per cent. The 1924 rates, reaching a maximum of 40 per cent, were retroactively reduced to the level of the 1918 law and provision made for refund of amounts paid in excess of those rates. The gift tax, which had yielded only a small revenue, was likewise retroactively repealed. The exemption allowed each estate was increased to $100,000, and the credit for state inheritance taxes was raised to 80 per cent. The estate tax provisions were left unchanged in the revenue act of 1928.

The rates at present applying to estates in excess of the $100,000 exemption are shown in the table at the top of the next page.

As under the income tax, each block of a large estate is taxed at a different rate, so that the maximum payment upon any estate is well below the maximum rate of 20 per cent.

Eighty Per Cent Clause of the Federal Law

The so-called 80 per cent clause has been the subject of bitter controversy. During the congressional debates of 1926 much was said about the social justice of taxing inheritances, and resentment was felt on the part of some members of Congress at Florida's constitutional amendment of 1924 prohibiting the levying of income or inheritance taxes. It was predicted that Florida would become a haven to which the rich would retire to escape taxation. Florida's action played an important part in winning approval for the 80 per cent clause.

Through the operation of this clause a state which has no inheritance tax is subjected to a definite and considerable loss of revenue, while its decedents receive no benefit through the absence of a state tax. Similarly, a state whose inheritance tax rates do not equal 80 per cent of the federal rates loses the amount by which its rates fall short of that level. The effect is to extend a definite financial inducement to the states to adjust their rates to take full advantage of the federal credit. If they do not do so, estates within their jurisdiction simply pay that much more to the federal government, and the states lose revenue which they might have had without imposing any additional burden on their decedents.

The 80 per cent clause was attacked by many of the states as an invasion of their sovereign rights. Congress, they asserted, was attempting to dictate state fiscal policies. Since the rates in most of the states were considerably lower than the federal rates and it was necessary to raise them to take full advantage of the federal credit, it was charged that Congress was merely offering a bribe to the states to induce them to apply its social theories. That the chief purpose of the law was to raise revenue was denied in view of the fact that the federal government offered to hand to the states 80 per cent of the revenue yielded by the tax.

Florida went so far as to institute proceedings before the Supreme Court, asking leave to file a bill against the Secretary of the Treasury to restrain him from enforcing the estate tax law in Florida. In its decision in Florida v. Mellon the Court refused the state's request and affirmed the constitutionality of the law. Florida has now yielded to the pressure put upon it by the present act. By a referendum in November, 1930, the people of the state approved lifting of the constitutional prohibition of an inheritance tax. An estate tax based on the federal law and designed to absorb the 80 per cent credit became effective there May 16, 1931.

A few states have refused to raise their rates in response to the federal bid. In a majority, however, action has been taken to obtain the whole advantage of the federal credit. This has been done in most cases by superimposing on the existing inheritance tax a special estate tax based directly on the federal rates and solely designed to give the state full benefit of the 80 per cent credit. When the 80 per cent provision was inserted in the federal law, the hope was expressed that it would result in making the state rates uniform and that when that had been accomplished the federal tax could be repealed. Extensive equalization of the burden on estates has been achieved, but the prospect of eventual repeal of the federal tax has been lessened in the process. Since most of these special state taxes have been made dependent on the existence of the federal law and would automatically lapse if the federal law were repealed, the chances of its final removal are now remote.

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State Taxation of Inheritances

Experiments with inheritance taxation were made by some of the states prior to 1885, but the New York law of that year marked the beginning of the movement on an extended scale. By 1900 there were inheritance tax statutes in more than 20 states. At the present, time Alabama and Nevada are the only states without them. The Alabama constitution forbids an inheritance tax on direct heirs and limits any tax on collateral heirs to two and one-half per cent, but a movement is now under way there to make possible enactment of a law to give the state the benefit of the 80 per cent federal credit. An earlier Nevada law yielded little revenue and was repealed in 1924. Residents of the District of Columbia are subject only to the federal tax.

Two systems of inheritance taxation prevail among the states, the proportional and the progressive. The proportional system is used in only a few states, including Pennsylvania, Maryland, and New Hampshire. Beneficiaries are divided into two classes, nearest of kin and others, and there is a flat rate for each group. Pennsylvania grants no exemptions to either group. Maryland grants none to the second group but entirely exempts the first group. The theory of this system is that the relative value of legacies to the heirs should be the same after taxation as before. The more common system is the graduated, where the tax and the size of the exemption vary in accordance with the relationship of the beneficiary to the decedent.

Six states—Florida, Georgia, Mississippi, New York, North Dakota, and Utah—levy an estate tax rather than an inheritance tax. Small estate taxes are imposed in addition to inheritance taxes in Oregon and Rhode Island. Special estate taxes are also levied in about half the states to absorb any of the 80 per cent federal credit not taken care of by the regular taxes.

New York changed its law a year ago from the inheritance to the estate type. It was held that the estate tax was simpler of administration than the inheritance tax and that differences in incidence between direct and collateral heirs could be arranged through exemptions based on the number and relationship of beneficiaries. This was done in the new statute, the exemption for the estate being made the sum of individual exemptions accorded the beneficiaries.

The table on the opposite page shows minimum and maximum rates and exemptions of the various state laws effective in May, 1931. The last column notes whether or not the full 80 per cent credit is absorbed, either by rates of the basic state statute or by a special additional estate tax. The minimum rate ordinarily applies to the smaller bequests to direct heirs, while the maximum rate affects the larger bequests to the most remote class of collateral heirs, or strangers. Similarly, the smaller exemption is on bequests to strangers or distant relatives while the larger usually applies only to bequests to husband or wife, sometimes only the latter.

Multiple Inheritance Taxation and Reciprocity

Double or multiple inheritance taxation among the states has arisen in the past as a result of the imposition of a transfer tax on intangible personal property of a non-resident decedent. The state of domicile taxes all the property of a resident decedent except real estate situated without the state and tangible personal property having a physical situs outside the state. But a tax on intangible personal property, such as stocks and bonds, may be exacted by the state in which the corporation is chartered; and until the practice was declared illegal by court decision, a tax on transfer of stock was often demanded by states in which the corporation merely held property. Tangible personal property located outside the state of domicile was sometimes taxed by the state of domicile as well as the state in which the property was held. In 1925 the Supreme Court decided in the Frick case that it could be taxed only where it had a physical situs. There have been various other types of double taxation, but that concerning intangible personal property is the most important.

Until the situation was largely corrected by passage of reciprocity laws, the estate of a wealthy person having large and diversified stock holdings might have to pay taxes to any number of states as well as the federal government. There were even cases where the stock of a single corporation was subject to transfer tax in a number of states; the New York Central Railroad, for example, is incorporated in six states, and before the era of reciprocity all of them might claim a tax.

Under such conditions it was necessary to exert great care in the investment of an estate in order to avoid ruinous death taxes. Unless this was done, it was possible that in extreme cases an estate might be almost, if not entirely, wiped out by taxation. Another danger to an estate was that it might be greatly reduced by passing successively through several beneficiaries within a few years, in the event of a succession of deaths within a family. The federal law now provides protection against this contingency by exempting from the estate tax any property already taxed under the statute within the preceding five years.

A further danger of heavy multiple taxation was the injury that might thus be caused an estate through having to convert capital assets into cash within a short time to pay the taxes. Although the time for payment of the federal tax may be extended to five years, most states require payment within one year following the death of the testator. If it is necessary to obtain cash by the forced sale of real estate or large blocks of securities, the assets of an estate may be seriously reduced. In cases of estates known to be heavily interested in particular stocks, the whole market for those stocks may be depressed and other holders as well as the estate suffer accordingly.

The estate of Frank W. Woolworth had to pay a federal estate tax of $6,800,000 and a state tax of $1,050,000. In order to obtain the necessary cash, the executors were obliged to sell the merchant's Fifth Avenue residence at its assessed value, mortgage the Woolworth Building, and retire an issue of the Woolworth Company's preferred stock, of which the estate held $2,000,000. Death taxes on the $957,000 estate of Theodore Roosevelt amounted to $86,988, and there was only $3,463 cash in the estate. Unusual means were adopted to obtain cash to pay some $9,000,000 of taxes on the $42,000,000 estate of Henry E. Huntington. The whole amount was covered by issuance of five-year 6 per cent notes against the estate.

In 1924 public attention was called to the evils of multiple inheritance taxation through the efforts of the National Tax Association, bankers, and economists. Tax officials of Pennsylvania, New York, Massachusetts, and Connecticut coöperated to obtain passage of legislation in their states the following year, whereby each agreed not to tax the intangible personal property of non-residents domiciled in states which granted them the same consideration. This movement spread rapidly until now there are only nine states—Arizona, Kansas, Kentucky, Minnesota, Montana, North Dakota, Oklahoma, South Dakota, and Utah—which do not grant reciprocity or come within the scope of the movement through absence of any tax on intangibles of non-residents. Since all of the important industrial states are included in the reciprocal group, overlapping of state inheritance and transfer taxes is no longer a serious problem.8

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Revenue from Federal and State Death Taxes

Revenue from the federal estate tax reached a high point in the fiscal year 1921, when the levy yielded $154,043,260. Since then, due primarily to reductions in rates and a change in the exemption and credit allowances, the revenue from this source has declined almost steadily. The total revenue from state death taxes, on the other hand, has constantly risen. Since 1927 it has surpassed the yield of the federal tax. The following table records the revenue received from federal and state taxes in recent years and notes the percentage of this revenue to the total revenues of the federal government and of the state governments, respectively.

As previously stated, the federal law of 1926 raised the exemption allowed on each estate from $50,000 to $100,000 and increased the credit for state inheritance taxes from 25 to 80 per cent. According to figures published in the Treasury Department's Statistics of Income, the aggregate amount claimed as credit for state taxes by returns filed during the calendar year 1929 equalled 73.4 per cent of the total tax before deduction of the credit. This indicates the extent to which the states have altered their laws to take advantage of the 80 per cent federal credit.

It should be pointed out that the federal estate tax does not actually yield amounts as large as those shown in the foregoing table. The figures are reduced each year by refunds on account of taxes erroneously collected. There are also frequent cases where the administrators of an estate pay to the federal government the whole sum of the federal tax, the amount credited for state taxes being returned when actual proof of payment of those taxes becomes available. The figures quoted in the table may be an overstatement by as much as $10,000,000. The actual net amounts are not published by the Treasury Department.

Methods of Avoiding Heavy Inheritance Taxes

Avoidance of part or all of the burden of death taxation was not difficult under the early laws in this country. These statutes, for example, had no provisions taxing gifts made “in contemplation of death.” A man on his deathbed could give away all his property and the state had no recourse. While many of the loopholes permitting avoidance of the tax have now been filled up, there are still numerous methods by which the levy can be substantially reduced, if not entirely avoided, without coming into conflict with the law.

The incidence of graduated rates may be evaded in some states by dividing an estate into numerous parts, the testator having an understanding with each beneficiary to turn over his portion to a designated indivdual. A hypothetical case is that of a Massachusetts estate of $50,000 which a man wishes to leave in its entirety to his widow. If it were bequeathed to her outright, the tax would be $750. If, on the other hand, it were divided among five children, each agreeing to give his share to the mother, there would be no tax, since direct heirs are each allowed an exemption of $10,000. Another method of accomplishing a similar purpose is to make bequests to distant relatives or strangers through the intermediary of near relatives, the latter being granted larger exemptions and lower rates; one state, Iowa, has a law which seeks to tax such transfers as if they went directly to the ultimate beneficiary.

The process of “marshaling assets” is practiced, except in those states which forbid it, for the purpose of reducing taxes. This consists of satisfying the interests of individual beneficiaries by particular parts of estates which may be located in their states, rather than by a general pro rata distribution of all the assets among all the beneficiaries. The practice often makes it possible to take advantage of more favorable laws than would otherwise be the case. In states where marshaling is forbidden a testator can accomplish the same result by making specific bequests of particular properties.

Incorporation of individuals for purposes of reducing death taxes is less common now than before correction of the overlapping of inheritance taxes. The practice is to form a corporation to acquire and hold all or part of the estate and assets of a wealthy person. At death, only the corporation stock, and not that of its various holdings, is taxable, and the estate is thus subject to death taxation only by the federal government and the state of domicile. The personal corporation may sometimes be used for further avoidance of inheritance taxes through distribution of large amounts of non-voting stock among the prospective heirs, the creator of the corporation withholding a limited issue of voting stock to be disposed of by will. He thus retains control of his property but distributes evidences of its ownership by a non-taxable transfer before his death. Care has to be taken, however, not to bring such transfers within the scope of “gifts in contemplation of death.”

Certain types of trusts are sometimes used to evade inheritance taxation, but it is more difficult now than formerly to get around the law in that manner. The practice of escaping taxation by creation of a joint estate has also been stopped by amendments of the various laws. Since large or complete exemptions are granted for insurance, it is sometimes possible to avoid taxes through use of insurance trusts.

Evasion Through Gifts in Contemplation of Death

Although the provision in most death tax laws subjecting to taxation gifts made in contemplation of death undoubtedly exerts a restraining influence on many testators, it is not impossible of evasion. A. W. Gregg, former general counsel of the Treasury Department, points out that “in no important case in the courts has the government been successful in proving that a gift was made ‘in contemplation of death.’”9 He cites a case in which a gift made to his natural heirs within two weeks of death by a man in his seventies, suffering from diabetes and pneumonia, was held not to have been made in contemplation of death.

John Wanamaker, who died in 1922 at the age of 84, transferred, less than two years before his death, to his son Rodman, with trust provisions for his two daughters, business properties in Philadelphia and New York valued at $36,790,376. The federal government, holding that the properties constituted 95 per cent of the total estate, claimed that the transfer was made in contemplation of death and that taxes of $10,041,932 were due. The Board of Tax Appeals ruled in favor of the estate and was upheld by the Court, of Appeals for the Third Circuit. The Supreme Court denied a petition for review of the case, April 20, 1931.

The federal law was amended in 1926 to provide that any gift within two years of death should be conclusively presumed to have been made in contemplation of death. A similar provision in the Wisconsin law has been held unconstitutional by the United States Supreme Court. The federal amendment itself was declared unconstitutional by federal district courts in New York (July 30, 1931) and in Delaware (August 28, 1931). Confirmation of these decisions by the Supreme Court is expected.

In view of the prospective invalidation of the present tax on gifts made within two years of death, Congress is expected, in connection with any upward revision of estate taxes, to reenact an outright gift tax, freed of the qualifications of the present law. It may at the same time undertake a general investigation of evasions of the federal estate tax.

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Footnotes

[1] See “Federal Taxation of Large Incomes,” E. R. R., Vol. I, 1931, pp. 179–195, and “Taxation of Capital Gains,” E. R. R., Vol. I, 1931, pp. 15–29.

[2] Outlook and Independent, May 20, 1931. “Wealth Rises to the Top,” pp. 78–79.

[3] National Wealth and Income (1926), pp. 58–59.

[4] The National Income and Its Purchasing Power (1930), p. 180.

[5] Ibid., p. 178.

[6] Public Finance (1924), pp. 487–488.

[7] Death duties in Great Britain now reach a maximum of 50 per cent in contrast to a maximum of 20 per cent here. Federal and state death taxes combined have never yielded annually more than about $215,000,000.

[8] In the case of Farmers Loan & Trust Co. v. Minnesota the Supreme Court decided, January 6, 1930, that “in general intangibles may be properly taxed at the domicile of their owner and we find no sufficient reason for saying that, they are not entitled to enjoy an immunity against taxation at more than one place similar to that accorded tangibles.” This decision appears to provide a final legal safeguard against multiple inheritance taxation by the states.

[9] National Sphere, April, 1931, “Judicial Erosion of the Federal Estate Tax,” p. 23.

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Special Focus

Number of Large Income Taxpayers, 1921–1929

Income of the Richest One Per Cent of Taxpayers

Present Federal Estate Tax Rates

Digest of State Inheritance Tax Laws

Yield of Estate and Inheritance Taxes

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