Harry Geels: Inheritance tax is a tax on future prosperity
This column was originally written in Dutch. This is an English translation.
By Harry Geels
Supporters of higher inheritance taxes argue that an inheritance represents a form of new income for the beneficiary and should therefore be taxed heavily, just like earned income. Opponents point out that the assets have often already been taxed before and refer to this as double taxation. However, there is a third, less frequently heard perspective: that of classical economics.
Classical economists distinguished between factors of production and the income they generate. Labour generates wages, capital generates interest, dividends and rent, entrepreneurship generates profits, and land generates rental income. This distinction is important—not because factors of production should never be taxed, but because taxes on the income generated by productive assets are generally less distortive than taxes on the productive assets themselves.
Taxing a share of profits does not directly affect the underlying business. Taxing the business itself, however, can influence investment, innovation, or even the survival of the company. The same applies to land ownership, agricultural businesses and other forms of capital. From this perspective, the relevant question is not whether an inheritance can be classified as income, but rather what the consequences of taxation are for maintaining productive capital and the prosperity generated by that capital.
Adam Smith’s tax principles
Adam Smith, widely regarded as the founder of modern economic science, formulated four well-known principles for sound taxation in The Wealth of Nations. First, equality: citizens should contribute according to their ability to pay. Second, certainty: clarity about the amount, timing and method of taxation. Third, convenience: taxes should be collected at a practical time. Fourth, efficiency: economic distortions and collection costs should remain limited.
These principles remain a useful benchmark. Consider a family business that passes to the next generation after the owner’s death. A substantial tax liability may force assets to be sold or significant debts to be taken on. In such cases, this creates tension with Smith’s principles of convenience and efficiency. The tax is levied at a legal transfer point, but not necessarily at a time when liquid assets are available or when the business is performing well.
The same issue arises with agricultural land, real estate portfolios and stakes in privately held companies. Valuation is often complex, and paying the tax can be difficult when wealth is largely tied up in productive assets.
Inheritance tax is not a wealth tax, but it does tax wealth
Supporters of inheritance tax make a valid point when they argue that inheritance tax is not the same as an annual wealth tax. A wealth tax taxes ownership year after year. Inheritance tax is imposed only once, namely when ownership transfers from one generation to another. This is a meaningful distinction.
Supporters also argue that an inheritance represents an increase in wealth for the recipient for which no labour was performed and no entrepreneurial risk was taken. This argument deserves serious consideration. It explains why some classical and classical-liberal thinkers also saw room for forms of inheritance taxation. However, it does not answer the question of how high such a tax should be. That is where the debate shifts from fairness to economic consequences.
Productive capital takes many forms
In debates about inheritance tax, an implicit distinction is often made between “genuinely” productive assets, such as family businesses, and financial assets, such as share portfolios. Economically, this distinction is less clear-cut than is often assumed. Listed shares represent ownership rights in companies that invest, produce, innovate and create employment. Financial markets serve precisely the purpose of allocating capital to productive activities.
When an heir has to sell part of an investment portfolio to pay inheritance tax, the consequences may be less visible than when a factory or farmland is sold, but that does not mean there is no distortion. Capital is still withdrawn from the existing allocation decisions of private investors. Other effects may occur as well.
Sales may take place at an unfavourable point in the market cycle. For larger holdings, transactions can influence the realised price. In addition, resources are shifted away from private investors—who are continuously assessed on returns and capital allocation—towards the government, where it is not automatically the case that these resources will be used more productively. The economic question is therefore not whether wealth is liquid or illiquid, but whether taxation results in a less productive use of capital.
The semantic debate distracts from the core issue
Today, it is often argued that an inheritance is simply income for the recipient. Economically, the picture is more complex. An inherited company is different from a payslip. An inherited farm is different from a bonus. The same applies to an inherited investment portfolio. In all cases, what is transferred is ownership of capital goods that can generate future income streams.
By viewing an inheritance solely as income, the distinction between consumption income and productive capital disappears. Yet this distinction played a central role in the thinking of many classical economists. The question is not only what the heir receives, but also what the economy loses when productive capital is drawn upon.
A classical-liberal conclusion
The debate on inheritance tax should therefore not revolve around the semantic question of whether an inheritance constitutes income. The relevant question is which form of taxation causes the least economic harm. From the perspective of the classical economic tradition, it makes sense to tax income derived from factors of production more heavily than the productive assets themselves or their transfer. Not because all inheritance taxation is unjustified, but because capital formation is the foundation of investment, productivity growth, entrepreneurship and ultimately rising living standards.
An inheritance can be viewed as an increase in wealth for the heir. At the same time, it remains a transfer of productive capital that can generate future prosperity. The classical economic tradition therefore warns against taxation that unnecessarily disrupts capital formation, entrepreneurship and economic continuity. This does not necessarily argue for abolishing inheritance tax. It does, however, argue for considerable caution when considering further increases.
Ultimately, prosperity does not arise because existing capital is repeatedly transferred between owners, but because productive assets continue to invest, create businesses and innovate. Those who levy inheritance tax therefore do not only tax an inheritance—they also tax part of the future prosperity that this capital could have generated.
This article contains the personal opinion of Harry Geels.
