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Tax Me, I’m Ecuadorian

By: Oswaldo Toscano - @otoscano_ec - May 29, 2015, 11:03 am

EspañolFor Ecuadorian President Rafael Correa, inherited property is a “fundamental factor in inequality.” As a result, he thinks it is necessary to modify the tax on inheritances worth more than a hundred basic salary units: that is, those over US$35,400.

The reasoning is that the accumulation of capital distorts the foundations of a society based on meritocracy, and that inheritances bestow an advantage on an individual compared to the rest of society, without him having made any effort to acquire it.

The news, as expected, generated a strong reaction from classical liberals in Ecuador, who saw in the measure yet another intervention in private property to satisfy the expenditure of a voracious state apparatus that grows to the detriment of their pockets.

The website of the country’s Internal Revenue Service (SRI) currently shows a table detailing the percentages of taxes on incomes from inheritances, legacies, and donations, which range from 5 percent to 35 percent, with the latter bracket being for those inheritances greater than $778,670. The definitive changes will become known in the next few days, when the proposals will be sent to the National Assembly, which is dominated by the ruling Pais Alliance party.

With this measure, Correa seeks to reduce inequality through a corrective measure on property transferred by a donor or deceased individual to a beneficiary or heir. This would apply to cash, bank accounts, shares, bonds, property, businesses, technology and machine equipment, automobiles, life insurance policies, works of art, and personal objects, as dictated by Ecuadorian law.

The reality is that the application of progressive tax brackets on inheritances, with the objective of diminishing inequality in property ownership, affects the quantity of capital that individuals are able to accumulate through a process of saving and intergenerational investment. In theory, this accumulation allows them to generate a greater income, which supposedly is one of the causes of the increase in relative poverty. In fact, this is one of the proposals made by Thomas Piketty in his book Capital in the Twenty-First Century.

For the French economist, when the rate of return on capital is greater than the rate of growth of the economy, income inequality increases, inheritances are a source of increasing income, the capitalists are left with an ever-greater slice of the pie, thus heavy taxes on inheritances are required. That’s to say, a tax that directly affects property thus seeks to eliminate what it considers to be an unjust accumulation of capital on the part of those writing up their will, who set their heirs on the path to unearned wealth.

However, a study carried out by Columbia University professor Xavier Sala-i-Martín shows that the families who were among the richest in 1987 are not the same as in 2013.

Fuente: “Economía Liberal para no economistas y No Liberales”, Xavier Sala i Martín.
Source: Liberal Economics for Non-Economists and Non-Liberals, Xavier Sala i Martín.

What’s clear is that accumulation of capital doesn’t generate income per se. The capital has to be made profitable, generating value for other people: that is, offering goods and services that people value. If you own a commercial space, this isn’t only going to generate profits by itself; you also have to attend to the needs of third parties: for example, by setting up a shop or pharmacy, or lending it to someone who will.

To increase and even just to maintain wealth requires business skills, and according to Ludwig Von Mises, it’s always an operation that puts the property at risk. As such, the value of capital comes from future expectations of profit, represented by the present value that the capital is capable of creating.

This means that if a property ceases to generate expectations of future income, it loses its value. As such, inheriting a share in property doesn’t represent an absolute guarantee of continuing to accumulate capital. Policies such as Correa’s involve adversely affecting inheritances and legacies, directly attacking private property, diminishing the incentives to increase long-term savings, without boosting the incomes of those it seeks to help.

It’s important to remember that salary levels are the product of the stock of accumulated capital in a society; lower rates of capitalization mean less productivity, lower salaries, and therefore, more poverty. In many cases, the heirs are forced to sell part of their property to cover said costs, something which causes instability or even interruption of business activities. Business families make up the very commercial fabric of Latin America.

In conclusion, to reduce inequality through a tax on patrimonial assets sourced from inheritances and donations only impoverishes those who are better-off, and diminishes income inequality by impoverishing everyone equally. The challenge is to enrich the poor without impoverishing the rich.

It’s important to emphasize that lowering the tax threshold in Ecuador, thus widening the number of contributors, will affect above all the Ecuadorian middle class, who have already paid previous taxes on inherited property.

The question that remains is: does the inheritance and donation tax really have redistributive ends in mind, or is it in reality a measure to satisfy the current fiscal needs of the Correa administration?

Translated by Laurie Blair. Update: 1 p.m. EDT, May 29, 2015.

Oswaldo Toscano Oswaldo Toscano

Oswaldo Toscano is an Ecuadorian professor, businessman, and columnist for outlets in Ecuador, Colombia, and Spain. A History PhD candidate at Francisco Marroquín University in Guatemala, he also studies at SMC University for a master's degree in political economy. Follow him: @otoscano_ec.