Volume 1
Death and Taxes

In essence, tax can be simplified into two categories: those that occur before one’s death and those that occur after. Of the two, it is surely the estate duty that is levied after one’s death that is the more odious. These are the taxes that have brought aristocratic families to their generational knees; that have led to the fire sale of chateaux, unravelled balanced equity portfolios and disrupted the ownership structures of major private firms worldwide.

Estate duty – or ‘death tax’, as it is known – has been on the frontline of the war that has been waged for centuries now, between the concept of competitive free-market capitalism and the socialist ideal of fair distribution of wealth. The capitalist argument is simple: one can understand to some extent the necessity for tax on one’s income and even on one’s capital gains during one’s lifetime. But it is something entirely different to accept the idea that one’s wealth – at the very point of departure from this mortal coil – should require a significant haircut.

In the case of Europe and the US, this haircut constitutes up to 40 percent of net asset value. During one’s lifetime, the balance between the capitalist argument (innovation, entrepreneurship and the creation of jobs) and the socialist agenda (fair distribution of wealth, free healthcare, social grants, and education for all) is to some extent achieved. Estate duty, at the point of one’s death, pushes the balance between these opposing arguments out of alignment.


Piketty’s Proposed Solution

Thomas Piketty, the French economist who shot to fame after making a study of inequality and publishing his findings in 2014 in a door- stopping tome, makes a very compelling point with regard to capital gains tax that is instructive in considering death tax rates. As a sidebar to his broad geopolitical research, he makes reference to the Forbes list of the 400 wealthiest families. He essentially asks the question as to whether the capitalist argument that the rich ‘deserve’ their wealth is valid. The capitalist argument is based on the idea that the rich deserve their riches because they make the world a better place – as we said, creating jobs, enhancing efficiency, innovating.

To make his point, Piketty chooses to compare the increase in wealth of Bill Gates to the gains made by Liliane Bettencourt, the heiress to the L’Oreal empire, and the wealthiest French citizen alive today. Roughly speaking, over the same period, Bill Gates went from a net worth of USD 20 billion to USD 80 billion, whereas Bettencourt went from an inherited fortune of USD 10 billion to her net worth today of USD 40 billion. The relative capital gain in both cases is the same, in spite of the fact that Gates built value through Microsoft whereas Bettencourt inherited value through L’Oreal.

To Piketty’s mind, this is evidence that free-market capitalism is a system that is out of control. There are a disproportionate number of names in the list whose wealth has simply been inherited. True innovation and job creation is in poor correlation to the compound annual growth rate experienced over the last 15 years by the constituents of the Forbes list.

Piketty has become somewhat notorious for his suggestion of a particular solution. He has been vilified by free-market economists for ‘mistakes’ in his data, crucified by capitalist commentators and their publishers as a communist, and adopted as a sort of intellectual version of a 21st Century Che Guevara by left-wing political elite, in countries such as Bolivia and South Africa. His suggestion is simple and politically unlikely. He recommends a progressive capital gains tax of 10 percent per annum, rather than the obsession in Western society with death tax. He advocates the erosion of Bettencourt’s wealth during her lifetime, quite simply, rather than after it.


Capital Gains Tax in Action for Bettencourt

If one were to apply his progressive capital gains tax retrospectively to Bettencourt, one derives some interesting results. Imagine a hypothetical scenario in which Bettencourt had received her inherited wealth in L’Oreal stock and then, for the past fifteen years, the stock had neither lost nor gained value at all. Now imagine that she had been subject to Piketty’s capital gains tax. In this scenario, Bettencourt’s wealth would have been whittled down to a paltry USD 2 billion from her original USD 10 billion windfall inheritance. Now imagine a second scenario, the one in which her actual L’Oreal stock gain is factored in, but in this scenario she still pays her Piketty tax. As it happens, in this second scenario her net worth goes from USD 10 billion to almost precisely the same over fifteen years; USD 10 billion.

The progressive capital gains tax rate that Piketty proposes happens to be roughly equal to Bettencourt’s actual gains – a stupendously strong after tax return. The most successful traditional software company ever, as well as one of the most successful cosmetic brands in Europe, have achieved compound annual growth rates that only just marginally exceed the proposed wealth erosion tax. One wonders if Piketty perhaps made use of Bettencourt’s gains as a rough guide to determining his apparently arbitrary progressive capital gains tax rate.

Were one to apply the same Piketty tax logic over a substantial period of time to less dominant firms, but to firms that are both innovative and essential to job creation – Tesla as an example – it becomes clear that Piketty’s tax would essentially cause the fire sale of equity by major shareholders to simply pay their tax.


Tax Laws in the Land of the Living

Irrespective, it is unlikely that any Western democracy will come any- where near to implementing the proposed progressive capital gains tax. Putting aside the glaring fault inherent in the proposed tax rate itself, there remains the simple reality that it is far more difficult to pass radical tax laws when one’s political and economic opponents are living, than it is when they are dead.

If there is to be no substantial increase in capital gains tax then, and Western democracies stick with punitive estate duties, two legitimate arguments can be lobbied by the rich. Firstly, for the individual who has created wealth, the primary rationale for its accumulation – putting aside Gulfstreams, New York penthouses, and super yachts – is that hoarding is not for one’s own utility, but rather it is for the benefit of one’s children and their children.

Secondly, and of more practical urgency, is the fact that estate duty is payable immediately. This is true in practice in respect of assets that are often extremely illiquid, including family country estates, high-value metropolitan property, and on substantial portions of ownership in private companies and listed firms. In fact, it is legally impossible for heirs to inherit any wealth at all until such taxes are paid. There are many cases of previously over-privileged who have spent years in financial purgatory whilst their parents’ estates are being wound up.

Over the past 150 years, since the tail-end of the industrial revolution, there has been a steady migration of wealth concentration – rather than wealth itself – from regal entities to aristocratic families and then on to entrepreneurial individuals. This migration has been caused mainly by two forces of change; political and social upheaval in the form of war, and tax. One only needs to watch the popular TV series Downton Abbey to observe this. In the early seasons, their sons and heirs are slaughtered on the battlefields of Europe, and in the latter seasons their estates are sold for taxes.

In Western democracies, as Piketty has proven, in spite of high tax rates both during one’s lifetime, and at the point of one’s demise, inequality has reached its highest levels in over a hundred years. The battles between the forces of free-market capitalism and the socialists are fought in the offices of lawyers and in the vessels of trusts and offshore tax-havens, rather than with tanks and ballistic missiles.

For example, there is a minor loophole in terms of how hedge fund managers treat their accumulated income gains on the portfolios they manage offshore. Once this loophole is closed in 2017, it is estimated that the tax windfall that will accrue to the US government will be in the order of USD 25 billion. Leading hedge fund managers have moved house and home in the past six months in anticipation of this impending change to tax law.

The moral and political question as to whether punitive death tax is appropriate within the context of the geopolitical dominance of free- market capitalism has become irrelevant. The side occupied by the rich has been for several decades now utterly eroded by its use of tax havens and the wilful misinterpretation of tax law. Foundations, trusts, wrapper endowments and a raft of small islands have been the undoing of any real debate on the question of appropriate balance. The haircut tax rate for dying remains high, owing to the difficulty in its collection.


Death and Taxes

The phrase “death and taxes” was first observed in Daniel Defoe’s The Political History of the Devil, published in 1726. It was later Benjamin Franklin who lifted the phrase from Defoe and made it the perennial sound bite that it is today. “Our new constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain except death and taxes,” he wrote in a letter to Jean-Baptiste Leroy in 1789. One of the great politicians of all time, one of the founders of democracy itself, the very man who became a poster boy for the French Revolution, in this statement places the immutability of tax and death at a higher level of permanency even than the democratic ideals he authored.

Most unfortunately, and with  uncanny  prescience,  Franklin seems to have got it spot on. In today’s context, in which the second-largest economy in the world is an authoritarian regime and in which the bastion of capitalism and trade in the form of the United Kingdom has voted effectively to exit the free market, it would clearly seem that tax, and especially death tax, has more chance of survival than the democratic ideals of the 18th century. One suspects that Franklin would have been surprised to learn how far his ideas have come, and perhaps somewhat disappointed in their implementation.