c' 

EQUITY AND THE TAXATION OF WEALTH TRANSFERS 

Eugene Steuerle 

U.S. Treasury Department 

OTA Paper 39 June 1980 

OTA Papers are circulated so that the preliminary findings of 

tax research conducted by staff members and others associated 

with the Office of Tax Analysis may reach a wider audience. 

The views expressed are those of the author, and do not 

reflect Treasury policy. Comments are invited, but OTA 

Papers should not be quoted without permission from the 

authors. Managing editors are Michael Kaufman and 

Gary Robbins. 

Office of Tax Analysis . U.S. Treasury Department, Room 1116 

Washington, D.C. 20220 

Issued: June 1980 
TABLE OF CONTENTS 

PAGE 

ABSTRACT ....................................... 1 

I. BACKGROUND .................................... 2 

I1. PRINCIPLES OF EQUITY AND THEIR RELATIONSHIP TO 

THE TAXATION OF TRANSFERS OF WEALTH ......... 5 

A . Three Approaches to Equity ................ 5 

B . Ability to Pay in the Presence of 

Wealth Transfers ........................ 8 

I11. CHOICE AMONG TRANSFER TAXES ................... 14 

IV. APPLYING EQUITY PRINCIPLES TO THE FEDERAL TAX 

SYSTEM: THE CASE FOR AN ACCESSIONS TAX ...... 17 

V . CONCLUSION .................................... 21 

BIBLIOGRAPHY ................................... 22 
-- 

Equity and the Taxation of Wealth Transfers * 

ABSTRACT 

Although the estate and gift tax is an important part of 

the Federal system of taxation in the United States, little 

attention has been paid to those principles of equity by 

which the fairness of the tax can be judged. This paper 

examines those principles of equity relevant to the 

development of a tax on the transfer of wealth. To apply one 

principle of equity -- taxation according to ability to pay 

it was first necessary to develop a definition of lifetime 

endowment similar to the Haig-Simons definition of income 

normally applied to shorter accounting periods. The paper 

then demonstrates how the choice and design of a tax on 

wealth transfers depends crucially upon both the principle of 

equity being followed and the choice of taxpaying unit to 

which that equity principle is applied. In one application 

of these principles, it is found that an accessions tax, 

lee., a tax placed on aggregate wealth transfers received, is 

a more logical complement to an income tax than is the 

current estate and gift tax. 

a * I am indebted to George Barsness, Larry Dildine, Harvey

Galper, Michael Kaufman, Paul McDaniel, Joseph Pechman, Em11 

Sunley and Stanley Surrey for helpful comments, and to Amie 

Powell for her assistance in the preparation of the 

manuscript. 
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I. BACKGROUND 

Under current Federal law, there are no inheritance, 

succession, or gift taxes placed on wealth transfers received 

by individuals. Instead, the Federal Government imposes a 

tax on the non-charitable transfer of certain property by 

estates and donors. -1/ Technically, the current estate and 

gift tax is an excise tax upon transactions, though this type 

of tax is popularly regarded as a net worth tax. For the 

purposes of this analysis, this tax is treated as a 

progressive tax upon the cumulative transfers of certain 

property or net worth. 

In 1978, the net worth of individuals in the United 

States totaled approximately $6.5 trillion. -2/ Of this 

amount, only about $19 billion was actually taxed as taxable 

transfers in taxable estates -3/, while total tax collections 

equaled about $5.4 billion. Thus, if viewed simply as a tax 

on net worth, the current estate and gift tax is levied 

-1/ This paper does not deal with other types of transfers 

such as charitable or institutional transfers of wealth. 

-2/ Source: aoard of Governors of the Federal Reserve System,

1979. The value of tangible assets was $4.5 trillion;

financial assests, $3.5 trillion; and liabilities, $1.5 

trillion. 

-3/ That is, this is the amount of taxable transfers which 

are reported on estate and gift tax returns and which are in 

excess of the implicit exemption level implied by the unified 

credit . 
-3-

annually on a total base of less than one-half of 1 percent 

of the net worth of individuals, while total collections are 

less than one-tenth of 1 percent of net worth. -

4/ 

Similarly, if viewed as a tax on transfers, the tax base 

is still quite small. The exact percent of all 

non-charitable transfers that are subject to tax is difficult 

to calculate. No one knows how many billions of dollars are 

transferred through gifts of money, durables, educational 

expenses, etc. that are not subject to tax because of the 

moderate size or nontaxability of each individual gift. 

Nonetheless, less than 3 percent of all households owning 

less than a third of all financial and tangible wealth -5/ are 

subject to estate or gift taxes, and more than half of the 

sum of their reportable gifts and estates are not subject to 

tax. Given these facts, certainly no more (and probably much 

-4/ See Lampman (1962), Smith (19741, and Statistics of 

Income--1972, Personal Wealth Estimated from Estate Tax 

Returns for estimates of the size distribution of wealth. 

-5/ It should be noted that a restricted definition of "net 

worth" is created by confining net worth to tangible and 

financial assets. Other valuable assets of persons are their 

knowledge, ability, skills, and capacity to generate wage

income. These assets (or human capital) are never taxed 

directly except insofar as they yield a cash flow through

income. Moreover, transfers of knowledge and skills from one 

generation to another are not subject to tax. Thus, a 

definition of transfers broadened to include all human as 

well as physical capital would imply an even lower rate of 

tax on the transfers of wealth of individuals. 
-4-

less) than 10 percent of the monetary value of all transfers 

of financial or tangible assets is subject to taxation under 

current law. 

Despite the small size of current estate and gift tax 

collections relative to total net worth or total transfers, 

there is widespread belief that a system of transfer taxes is 

a necessary and vital element in a total system of taxation. 

The next section of this paper clarifies those approaches to 

tax equity upon which most arguments for or against certain 

types of transfer taxes are based. Section I11 shows how the 

choice and design of any transfer tax system can be made to 

follow directly from the principle of equity being followed 

and the choice of the unit of taxation. Section IV examines 

the current combined income and transfer tax system and 

concludes that an accession tax would be a better complement 

to the income tax than would an estate and gift tax and that 

an accession tax would come closer to meeting certain equity 

criteria that are implicit in the current estate and gift tax 

system. Finally, a conclusion is presented in Section V. 
-- 

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11. PRINCIPLES OF EQUITY AND THEIR RELATIONSHIP TO THE 

TAXATION OF TRANSFERS OF WEALTH 

A. Three Approaches to Equity 

Most taxes are justified in terms of one or more 

principles of equity. g/ Three principles of equity are 

discussed here, -

7/ and the choice among these principles in 

turn affects the choice of an optimal system of transfer 

taxation. These principles are: (1) ability-to-pay; (2) 

standard-of-living; and (3) equalization-of-wealth or 

equalization-of-opportunity. -8/ 

The ability-to-pay approach to tax equity requires that 

tax burdens be distributed according to the taxpaying unit's 

ability to pay. Originally, both in England and America, 

- m y the equity arguments for transfer taxes are 

mentioned here, since equity is the prime justification for 

the taxation of transfers. 

7/ Another common approach to tax equity (and efficiency) 

attempts to correlate taxes and expenditures in a "quid pro

quo" process. This "benefit approach" to taxation is 

generally not applied to transfer taxation. Of course, in 

the rare case where benefits more or less coincide with 

ability to pay, one reaches the same conclusions about the 

development of a transfer tax from either a benefit or 

ability-to-pay principle. 

-8/ Various "aims" of death and gift taxes are noted in 

Shoup (1966) or Jantscher (1977). These aims include: 

raising revenue, taxing capital periodically (or once a 

generation), taxing windfalls, reducing the concentration of 

wealth, and taxing a special type of ability to pay that 

resulting from the receipt of a gift or inheritance. 
-6-

ability to pay was measured by property ownership (Musgrave, 

1959, p. 94), although the emphasis has since shifted rather 

sharply to income. This shift has been evidenced by the 

large role of the personal income tax relative to other taxes 

in the 20th century. One reason for this shift has been the 

increasing importance over time of wage income to most 

households' well-being. When wages were thought to equal 

only subsistence income, they were treated as nontaxable by 

the central government. With the rise of entrepreneurs, 

managers, skilled laborers, and the growth of the middle 

class, wage income began to vary substantially from one 

individual to the next and for many could no longer be 

considered merely as subsistance income. Increasingly, the 

taxable base under the ability-to-pay approach has come to 

be defined as property plus wage income in excess of the 

subsistence level of income. The difficulty with income as a 

measure of ability to pay, however, is that it is only a one 

period measure of potential consumption that does not fully 

capture certain lifetime economic circumstances of the 

taxpaying unit, particularly transfers received. 

By contrast with ability-to-pay, the standard-of-living 

approach to tax equity, derived in part from the work of 

Irving Fisher, focuses less on what a taxpayer can consume 

during a given period of time than on what he actually does 

consume, i.e., what he actually draws from the "common pool" 

of resources of society. Under this approach, the consumption 
-7-

of the taxpaying unit determines its tax base. Wealthholding 

itself is viewed as providing no direct benefit (or, at 

least, no taxable benefit) to the individual above and beyond 

the consumption that it allows. Thus, in a given period of 

time, an individual's well-being or utility is presumed 

implicitly to be the same for a given pattern of consumption 

regardless of his net worth. To the extent that 

wealthholding provides certain benefits--for instance, 

insurance or option value not reflected in direct consumption 

outlays--those benefits are ignored and not considered as 

part of the standard of living. 

The third approach to tax equity argues for less 

inequality of wealth or opportunity in society. Less 

inequality itself implies a reduction in the variance in the 

amount of wealth owned by different individuals or families. 

Generally, an equalization-of-wealth or equalization-ofopportunity principle is invoked with regard to tangible and 

financial assets, rather than human capital, with the major 

exception of demand for equal educational opportunities. In 

the broadest sense, less inequality of wealth means bringing 

all parts of the wealth distribution closer to the median 

wealth. On the other hand, the policy objective may be a 

more limited one, such as constraining the amount of wealth 

held by top wealthholders or providing for ownership of some 

minimum amount of assets by the poorest part of the 

population. However, policies to achieve even these more 
-8-

limited objectives generally have an impact upon individuals 

in each spectrum of the wealth distribution. This result 

arises because taxes affect savings and investment decisions 

and because redistribution affects not only those who pay the 

taxes but those who receive the transfers or government 

services as well. 

As a policy objective, redistribution of wealth involves 

more than just a redistribution of consumption opportunities. 

Redistributive policy may also be directed toward preventing 

unusual concentrations of wealth or limiting the ability of 

top wealthholders to control economic resources. 

Redistribution of wealth to poorer families has also been 

justified on the ground that increments of wealth provide 

more benefit to poorer members of society than to richer ones 

and that some minimum amount of wealth is necessary to enable 

individuals to develop fully their human pot-ential, for 

example, through investrnent in education. 

B. Ability to Pay in the Presence of Wealth Transfers 

In treating transfers of wealth which are made and 

received infrequently over a person's life, a lifetime 

measure of ability to pay is preferable to a more limited 

single period measure of taxpaying capacity. Therefore, 

before proceeding, we will develop a definition of ability to 

pay on the basis of lifetime endowment rather than on current 
-9-

. 

period income or consumption. Lifetime endowment, like 

annual income, can be defined in terms of either its sources 

or its uses. Consider the simplest case: there are no 

bequests and gifts, there are constant rates of return, and 

investment rates of return are equal to marginal rates of 

time preference. -

9/ Then the following equation holds: 

Present Va1ue Present Value 

of Wage Income = Endowment = of Consumption 

However, individuals do make numerous and sometimes 

sizeable transfers and bequests, and an analysis of the total 

tax system irrespective of these transfers would be 

incomplete. Modifying equation (1) for the presence of 

transfers gives equation (2) : 

Present Present Present 

Value of Value Value of 

Transfers + of Wage = Endowment = Consump- + 

Received Income tion 

Equation (2) presents an extremely useful 

Present 

Value of (2)

Transfers 

Given 

reconciliation 

of a lifetime measure of sources of income with a lifetime 

measure of its uses. Income and consumption are often 

related over short accounting periods through the Haig-Simons 

concept that income equals consumption plus change in net 

worth (Goode, 1977). Equation (2) performs a similar 

reconciliation of income and consumption over the taxpaying 

-9/ That is, to calculate present value, it is necessary to 

discount wages and consumption by the same interest rate. 
-10-

unit's lifetime by relating them to the net change in value 

of transfers received (or given). Because of the longer 

accounting period involved, however, equation (2) differs 

from a Haig-Simons equation by converting flows of income, 

consumption, and transfers into present value terms. Because 

a dollar of transfer, income, or foregone consumption can 

earn interest, the present value calculation treats a dollar 

as worth more to an individual the sooner it is received. 

In the work of those concerned with the design of 

comprehensive consumption taxes, one can sometimes infer the 

"uses" side of equation (2). For instance, by "including 

gifts given and bequests in the (consumption) tax base of the 

donor ," Bradford and Toder (1976) allow that "a consumption 

tax can easily be transferred into an ability-to-pay tax for 

each generation'' (p. 31). Similarly, the "sources" side of 

the equation has been hinted by those concerned with the 

design of comprehensive income taxes. Pechman (1977) argues 

that "[blequests and gifts, like income from work or 

investments, are a source of ability to pay (emphasis added). 

In theory, therefore, they should be taxable as income when 

received" (p. 221). 

Under this lifetime accounting system, transfers given 

do not decrease the endowment, since the option to give them 

remains open to the giver. Transfers given are instead part 

of a tax unit's wealth to disperse, i.e., its ability to pay. 
-11-

Transfers received are also counted in the endowment because 

they increase the ability to pay or the option to consume of 

the receiver. 

Under an ability-to-pay approach to tax equity, if 

equals are defined in terms of the taxpaying unit's lifetime 

endowment, equation (2) indicates that an accessions tax 

(taxation of aggregate transfers received) would be an 

appropriate complement to an income tax on wages, while a 

unified estate and gift tax (taxation of aggregate transfers 

given) would be the proper complement to a consumption tax. 

Furthermore, equation (2) indicates that inclusion of wealth 

transfers in the tax base is necessary to make either a 

consumption tax or a wage income tax a tax on the ability to 

pay of each generation. 

Of course, with a constant rate of taxation on all 

transfers, a tax on either the transferor or the transferee 

would be equivalent. However, the existence of exemptions, 

deductions, credits, and a progressive rate schedule causes 

the two taxes to differ. In general, an accessions tax would 

yield less revenue from a given estate or gift as the number 

of persons receiving transfers from that estate or gift 

increased, while a unified estate and gift tax would yield 

less revenue from a person's aggregate gifts and inheritances 

as the number of persons making transfers to that person 

increased. 
-12-

When the case for a consumption tax is presented, it is 

often noted that an income tax on both wage and property 

income does not tax all persons equally because of its bias 

against those who save more of their income early in life, 

i.e, both wages and interest earned on savings from wages are 

taxed. However, the current income tax also has a bias 

against those who receive their endowment through wage income 

rather than gifts and bequests. In terms of equation (2), 

lifetime endowment recognized as wages is taxed directly, 

whereas endowment received through transfers is not. To 

observe this in the simplest case, suppose there were no rate 

of return on capital; income would equal wage income, and an 

income tax would only tax that portion of endowment 

recognized as wages, but not that portion received through 

transfers. Thus, the only way transferred endowment is taxed 

under an income tax is by including property income in the 

taxable base. 

In the absence of property income, a tax on transfers 

received would be a perfect complement to an income tax. 

However, since income is generated from capital and is taxed 
-13-

under an income tax, -10/ some portion of inherited capital

is taxed indirectly, so that the complementarity of an income 

tax and an inheritance tax is imperfect. Nonetheless, some 

form of transfer tax is needed to make an income tax closer 

to a tax on the taxpaying unit's ability to pay and to 

eliminate the bias which exists against those whose 

endowments consist largely of wage income. 

-10/ Actually, the individual income tax in the United States 

is fairly close to a tax on wage income, plus a penalty tax 

on realizations of certain types of nominal (rather than 

real) income from capital. Over 80 percent of the assets of 

individuals (including owner-occupied real estate and 

pensions) is in a form for which there is tax preference

arising through deferral, capital gains rates, exclusions or 

other means of non-taxation of the income from the assets. 

See Steuerle, 1980. 
-18-

In the lifetime accounting identity of the previous 

section, either transfers given could be added to consumption 

or transfers received could be added to wage income in order 

to measure lifetime endowment. Since an income tax is 

neither a wage income tax nor a consumption tax, it is not 

possible to argue that either a tax on the transferor or a 

tax on the transferee is the perfect complement to the income 

tax. Nonetheless, the income tax is clearly a tax on 

receipts rather than disbursements of income and is closer to 

a tax on wage income than a tax on consumption. A consistent 

application of the ability-to-pay principle would require 

that the transfer tax also be imposed upon receipts rather 

than disbursements. -11/ Thus, on an ability-to-pay basis, 

an accessions tax rather than an estate and gift tax would 

make a better, although not perfect, complement to the 

existing income tax. 

Yet, while the income tax is best considered as a tax 

based upon ability to pay, one critical feature of the 

existing estate and gift tax indicates that the equalization 

of wealth approach to equity was also an important 

-11/ One could also tax receipts of gifts and bequests under 

the income tax directly, although that would probably require 

a lifetime income averaging scheme. 
-- 

-- 

-- 

-19-

consideration in the development of that tax. The telling 

feature is the application of the estate and gift tax only to 

top wealthholders. Thus, the tax ignores most but not all 

transfers something that would not be allowed under a pure 

ability-to-pay approach except on administrative grounds. 

While there certainly are many transfers that are impossible 

to trace, and hence untaxable under any system, the estate 

and gift tax additionally provides quite generous tax-free 

levels of transfers on recorded transfers. These credits, 

exemptions, and deductions under which such tax-free 

transfers are allowed indicate a major purpose of the tax 

is to limit the wealth of top wealthholders. 

Even here, however, an accession tax would be preferred 

to the present structure of estate and gift taxes. As long 

as equalization of opportunity is desired across living 

members of society, the past wealth of the donor or decedent 

is of no consequence. It is the inheritance or gift received 

by the transferee that measures his additional opportunity or 

endowment vis-a-vis other members of society. Moreover, an 

accessions tax, rather than an estate and gift tax, will 

generally result in a greater dispersion of wealth for a 

given amount of tax collection. That is, the existence of 

exemptions and a progressive rate structure would permit an 

accessions tax to penalize the concentration of giving and, 

through the incentive of lower taxes, to reward the 
-20-

dispersion of gifts across many individuals. Additionally, 

unlike the estate and gift tax, an accessions tax does not 

result in lower aggregate taxes for those heirs who receive 

their transfers from multiple sources. 

Taxing inheritances and gifts received over a person's 

lifetime would also express a preference for imposing a tax 

on "good fortune" which is not related to the person's own 

effort, as opposed to the fortune or wealth of a donor or 

decedent which may be due to past effort. An inheritance tax 

explicitly works to equalize future opportunities for donees, 

while an estate tax more directly taxes the past successes of 

donors. 
-- 

-21-

V. CONCLUSION 

Current estate and gift taxes are levied on only a small 

portion of the net worth of individuals and an even smaller 

portion of their total transfers. Nonetheless, any tax 

L 

system should be based upon an underlying set of equity 

principles. Three principles of equity can be applied to the 

development of a transfer tax ability to pay, standard of 

living, and equalization of wealth. In general, however, 

only the first and the last principle justify a transfer tax 

rate above zero. 

When ability to pay is measured by lifetime endowment 

rather than single period income, a tax on transfers received 

is found to be a more logical, although not perfect., 

complement to an income tax than is a tax on transfers given. 

However, a tax on transfers received is definitely preferred 

under the equalization-of-wealth principle of tax equity 

because it penalizes the concentration of giving and rewards 

the dispersion of gifts across individuals through lower 

taxes. There is strong evidence that one or both of these 

equity principles forms the basis for the current taxation of L 

transfers and that, therefore, the goals of the current 

t estate and gift tax law can be better met by an accessions 

tax. 
-22-

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Atkinson, A. B. "The Distribution of Wealth and the 

Individual Life Cycle." Oxford Economic Papers (July,

1971), pp. 239-54. 

Barlow, Robin; Brazer, Harvey E.; and Morgan, James N. 

Economic Behavior of the Affluent. Washington, D.C.: 

The Brookings Institution, 1966. 

Bradford, David F. and Toder, Eric. "Consumption vS. 

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and Simplicity." Proceedings of the National Tax 

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Bradford, David F. "The Case for a Personal Consumption -

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Washington, D.C.: The Brookings Institution, 1980. 

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David, Martin. "Increased Taxation with Increased 

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Philadelphia: University of Pennsylvania, 1960. 
-23-

Musgrave, Richard. The Theory of Public Finance. New 

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Shoup, Carl S. Federal Estate and Gift Taxes. Washington, 

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