Follow the money: Tax inheritances, not estates

With a Republican-led federal government, there is substantial interest in tax reform. While all the individual provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 that expire at the end of 2025 will be of interest, our new research suggests the TCJA’s estate tax provisions warrant special attention and reveal a unique opportunity for policymakers.

The federal estate tax, paid by the estates of those who have died, could be converted to an inheritance tax, paid by those receiving proceeds from estates. That conversion would raise revenue, increase progressivity, broaden the income tax base, improve equity, and boost economic mobility. The taxation of wealth transfers will likely rise in importance over the next several decades, as the U.S. comes to grips with both the largest set of intergenerational wealth transfers in its history and looming large federal deficits.

The estate tax is not working

The estate tax is riddled with loopholes, making it difficult to administer and easy to avoid. A comprehensive tax on inheritances would not leave room for the many loopholes that plague the estate tax. By taxing heirs rather than donors, an inheritance tax could conform more closely to the economic circumstances of the recipient. It might also encourage the break-up of major estates, which would reduce wealth inequality and increase economic mobility. And an inheritance tax could raise more revenue than the estate tax does.

Our nation’s peers rely on inheritance taxes, not estate taxes

The U.S. is an outlier in the Organisation for Economic Cooperation and Development (OECD); many more of its member countries levy inheritance taxes than estate taxes. Of the 36 OECD countries, only Denmark, South Korea, the United Kingdom, and the U.S. tax estates. But 20 member countries tax inheritances, all according to some combination of the relationship to the decedent and the size of inheritance received. The countries have varying wealth thresholds below which inheritance amounts are exempt, but even the highest exemption level in other countries—€1 million in Italy (around $1.0 million)—is less than 10% of the current U.S. estate tax exemption level of $13.99 million.

Inheritance versus estate taxes

Comparisons of the estate tax and an inheritance tax have long been a staple of economic policy analysis. One key difference between the two is that people generally favor taxing large gifts received rather than taxing the wealth someone has accumulated. A nationwide survey conducted by Harvard economist Stefanie Stantcheva found that 61% of respondents believe it is unfair to tax estates of decedents who earned their own wealth. However, only 32% of respondents thought it fair that children of wealthy parents have “access to better amenities.”

An inheritance and an estate tax might also differ because of how they influence behavior. For example, if the goal of wealth transfer taxation is to reduce inequality, an inheritance tax is more effective than an estate tax. An inheritance tax targets large amounts of wealth individuals receive, while estate taxes apply to the entire estate. With an estate tax, a large fortune could be divided among several heirs, meaning each person might get a smaller amount and face less tax. In contrast, an inheritance tax focuses on taxing significant transfers to individuals, which makes it more effective at addressing inequality.  

Finally, an inheritance tax would correct one of the biggest omissions in the income tax system: income received by gift or bequest. Sound tax policy aims to tax all types of income. This cannot be achieved without taxing inheritances.

Despite repeated claims to the contrary, there is little evidence that wealth transfer taxes reduce capital accumulation or efficiency, and they certainly can be structured in ways that take account of the special considerations raised by small businesses or family farms.

What we found

Using data from the Survey of Consumer Finances, we use a new methodology to link bequests (what a person leaves to another) and inheritances (what a person receives from another). We assume that heirs bear the burden of the tax, similar to previous work.

We examined two stand-alone, flat-rate inheritance tax options: 37% (the highest income tax rate in 2024) or 15%. With an exemption of $2.81 million (for the 37% tax) or $940,000 (for the 15% tax), these options can raise the same amount of revenue as the 2021 estate tax. By definition, both inheritance taxes are very progressive relative to inheritance-inclusive income, because receiving an inheritance that exceeds either exemption will put any individual in the top 5% of earners.

Figure 1 shows that inheritance taxation is also very progressive relative to inheritance-exclusive income. Neither the 15% tax nor the 37% tax raise very much money from the bottom 80% of the distribution, and the 37% tax is more progressive than the current estate tax. This is possible both because of the high rate and because of the large exemption amount that the high rate allows. At a smaller exemption level of $1 million, the 37% inheritance tax raises more revenue than the estate tax does.

Conclusion

Our estimates show that inheritance taxes not only can raise more revenue and be more progressive than the existing estate tax, they can also broaden the income tax base, improve equity, and raise economic mobility. Policymakers should take these estimates into account as they evaluate wealth transfer tax options, as well as the nation’s fiscal health.