Income vs. Transfers

Michael at Half Sigma doesn't see why we should tax income but not inheritance:

The general rule is that whenever money is transferred from one party to another, there's a tax. If a hard working middle class person has a problem with his pipes, and he pays money to a hard working plumber to fix the pipes, the plumber has to pay income tax on the money he receives. So if a child of a rich person receives millions of dollars for doing absolutely nothing, why should he pay less tax than the plumber who actually did something useful?

The problem is that that's not at all what the general rule is. The income tax isn't a tax on money changing hands; it's a tax on added value, or production. When you buy groceries from the store, the store owner doesn't pay income tax on all the money you give him. He pays taxes only on the profit left over after covering all expenses---the value he adds as a retailer. His expenses may go to workers (taxed on wages earned for the value their labor adds), creditors (taxed on interest earned for the value their capital adds), suppliers (and here we recurse), etc. If you sketch out a tree showing where money changes hands and who contributes what and pays what taxes, and you can see very clearly that the income tax is not designed to kick in every time money changes hands.

There are a few exceptions to this rule, the most obvious being the corporate income tax. The gift tax is another. Michael also mentions lottery winnings

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