Tax Policy and Gifts

Abstract

Voluntary transfers between individuals are potentially subject to income taxes and wealth transfer(estate and gift) taxes. With regard to the income tax, Henry Simons (1938) argued that it should be levied both on the donor, whose gift is a form of personal consumption, and on the donee, who directly consumes the gift. Others would limit income taxat ionto the donee, the only one whose act of consumption dissipates real resources. Most income tax systems do tax gifts only once, but the single tax is imposed in a different, more administratively convenient manner: the donee is exempt, and instead the donor is taxed, implicitly, by not allowing any deduction for gifts. Yet the rationale for simply applying the labor income tax rate--whether once or twice--to gifts is dubious because, as I will discuss, the incentive, distributive, and other welfare effects of taxing gifts and of taxing labor income are different. Wealth transfer taxes, which in most developed countries are levied only on the estates of wealthy individuals, are often evaluated in terms of their redistributive effects. But such analysis is not usually integrated with that of the income tax, which is also a redistributive tool. Another factor suggesting the need for a more integrated treatment of transfer taxes and income taxation is that the effects of taxation on behavior and welfare will depend on the aggregate of taxes levied on a gift rather than on what portion of the tax is designated as a gift or estate tax and what portion is deemed to be an aspect of the income tax. Accordingly, this paper considers a single, unified framework for analyzing the combined taxation of gifts, one that incorporates existing analysis of redistributive income taxation. Using such an approach, I sketch a mapping between types of gifts and optimal tax policy. It is helpful, however, to begin by discussing how gifts should be taxed if they were simply another form of ordinary consumption.