What have your parents ever done for you...

Tristan writes in my comments box:

1. You are less likely to invest knowing that the state is going to take half your wealth when you die
2. And unless you scrap income tax, inheritance tax is a double tax
3. Would you tax someone because their parents gave them genes to be intelligent? They didn't have to do any work for that. Or perhaps being attractive?

I started responding, but my response became a post in itself so I thought I'd include it here.

• If the system is set up correctly then people should have incentives to save for retirement and then spend all their life savings after they retire so they die with zero wealth OR bequest the extra money to charity. This is a difficult one since people often don't know precisely when they're going to die, but IMO this is primarily a pensions management problem. Assuming people won't save assumes that you can't set up a system to encourage people to save and then spend most of the savings before they die. The government will still get a fair bit of money in inheritance tax even if the general trend is towards large-scale spending of estates in retirement and charitable bequests.
• Covered in the comments box. First, reducing income tax counteracts this to some extent. Second, if previously earned income shouldn't be taxed again then if I employ a plumber the government shouldn't tax his income because I've been taxed on my income already.

The third point requires a bit of a story.

Liberals believe in equality of opportunity. This means that everyone (ideally) should have the same opportunities in life. This means it's unfair if John Smith's parents are poor so he can only attend a school in special measures whilst Fred Bloggs' parents pay for him to attend Eton. John Smith and Fred Bloggs may have equal merit but John Smith doesn't have the same opportunities as Fred Bloggs. In reality, it's difficult to ensure this and its probably better if Fred Bloggs has lots of opportunities and John Smith has some, than both John Smith and Fred Bloggs have few opportunities.

To ensure equality of opportunity, the government should try to ensure that John Smith has access to a good school despite the fact his parents are poor. But the government needs to pay for this so needs to levy some taxes somewhere. The idea is to ensure these taxes are as fair as possible (obviously). Inheritance tax is a fair tax and fairer than income tax.

If we tax very wealthy people (Tristan's 'envy taxes') then this might be unfair. If John Smith works very hard after leaving his sink school, starts a business selling cows on brightly coloured treadmills to environmentally conscious urban dwellers who want fresh milk/greener electricity and after working 26 hours a day, 7 days a week for several years makes millions... then we're penalising John Smith for his hard work and bright ideas just because it annoys Fred Bloggs who's now working flipping burgers in McDonalds. Further, if John Smith knew he was going to be taxed through the nose, he may never have set up MooPod (TM) in the first place.

But we don't know if John Smith made his millions with MooPod because he was hard-working or because he has an IQ of 145 whereas Fred Bloggs has an IQ of 101. Around 50% of John Smith's IQ came from his parents and thus whatever proportion of his millions is directly due to his 44 point higher IQ is 'unearned income'. If we knew at birth that John Smith was going to make £44 million more than Fred Bloggs directly due to that 44 point IQ difference then the fairest thing would be to levy a 'gene tax' of £44 million to be repaid over John Smith's lifetime. This would mean that John Smith and Fred Bloggs start on a level playing field and any money John Smith earned above that earned by Fred Bloggs was due to the application of his skills for the benefit of society and his hard work. If we levied the 'gene tax' at birth based on average amounts of money earned as a result of particular skills (like IQ) then people would still be encouraged to display enterprise and hard work because the 'gene tax' would be a one-off payment unrelated to how hard they worked during their lives.

Unfortunately, a future government would find that it's 'gene tax' screening programme was more of a disaster than the current government's ID cards scheme. Because we can't decide if John Smith set up MooPod (TM) because he had a higher IQ or because his father instilled a work ethic in him from birth... or even because of a chance encounter with a cow on a treadmill during a school trip. Further, John Smith may have used his IQ of 145 to earn several million but Maria Jones (IQ of 150) may set up a band, fail to make a break and end up living in a caravan and busking. Hence, levying an average charge based on IQ would be deeply problematic - Maria Jones would never be able to pursue her dream to play the digeridoo professionally but would have to work for an investment bank to pay back her 'gene levy'. Further, if we try valuing people's genetic inheritance at birth, some parts are really subjective (like attractiveness - Brad Pitt does nothing for me) and how do we value football skills as opposed to IQ.

Now imagine that Joseph and Jane Bloggs die and leave Fred Bloggs £500,000. This is unequivocably absolutely nothing to do with Fred Bloggs' work ethic, his IQ or his talent at playing the harmonica using his toes. All he had to do to earn that money is sit waiting for his parents to die. This income is entirely unearned. Unlike John Smith's millions, there's no question whether Fred Bloggs sudden good fortune is due to his IQ (his 'unearned' income), his determination, vision and hard work (which may or may not be genetic but is 'earned'), his upbringing including his peer group and/or his life experiences. It's relatively easy (compared to the 'gene tax') to determine how much unearned income Fred Bloggs received from his parents. Further, Fred Bloggs receiving this money acts counter to equality of opportunity. Fred Bloggs has opportunities due to receiving this money which John Smith never had because his parents were poor.

The moral of the story - since you have to levy some taxes then taking the unspent and ungifted parts of estates in huge inheritance taxes is one of the fairest places to levy them.

Further reading: The Undercover Economist which I faintly remember talks about gene levies with reference to Tiger Woods.