Isn't it unfair for estates to be taxed after death? The person who bequeathed the estate probably purchased it with after tax money, so wouldn't it then be taxed twice? What is the purpose of the tax other than to generate funding for government spending?
From an equality of opportunity perspective, it is desirable to have some taxes on inheritance. This levels the playing field for each generation to some extent. If real estates are exempt from such a tax, individuals would prefer real estate over other assets, creating a distortion in the asset price market.
For a recent contribution to optimal inheritance taxation, see: Piketty, Thomas, and Emmanuel Saez. "A theory of optimal inheritance taxation." Econometrica 81.5 (2013): 1851-1886.
For an overview over the equality of opportunity literature, see: Corak, Miles. "Income inequality, equality of opportunity, and intergenerational mobility." The Journal of Economic Perspectives (2013): 79-102.
It may seem unfair that someone who has already met their tax obligations gets hit with another one after they die. From an economic standpoint, it is very popular.
I'll let this economist article explain it...
The gut dislike of death duties seems to arise because the tax clashes with heartfelt dynastic instincts
Any tax on capital will tend to dissuade people from accumulating the wealth in the first place, but a death duty is arguably one of the better options...
[The tax burden] falls on unintended legacies—money put aside to pay for old age, for example—as well as intentional bequests. Since unintended bequests are, by definition, not planned they should be unaffected by the prospect of the tax.
Death duties can also be justified in terms of fairness. A thriving economy will generate great fortunes, but there is good reason to check these becoming entrenched through inheritance. The estate tax offers a modest counterweight against the development of a new plutocracy to rival the industrial barons of America's Gilded Age. Furthermore it also taxes wealth built up through windfalls rather than thrift and effort.
Also, see this article by the well known Thomas Piketty (I just noticed another answerer included it as well) which provides a model of optimal inheritance taxation. In particular, read the introduction which covers a lot of useful background and an overview of the model. Piketty et al also provide the conditions in which a zero tax rate is optimal.
Here is the abstract:
This paper derives optimal inheritance tax formulas that capture the key equity-efficiency trade-off, are expressed in terms of estimable sufficient statistics, and are robust to the underlying structure of preferences.
We consider dynamic stochastic models with general and heterogeneous bequest tastes and labor productivities. We limit our- selves to simple but realistic linear or two-bracket tax structures to obtain tractable formulas. We show that long-run optimal inheritance tax rates can always be expressed in terms of aggregate earnings and bequest elasticities with respect to tax rates, distributional parameters, and social preferences for redistribution.
Those results carry over with tractable modifications to (a) the case with social discounting (instead of steady-state welfare maximization), (b) the case with partly accidental bequests, (c) the standard Barro–Becker dynastic model. The optimal tax rate is positive and quantitatively large if the elasticity of bequests to the tax rate is low, bequest concentration is high, and society cares mostly about those receiving little inheritance. We propose a calibration using micro-data for France and the United States. We find that, for realistic parameters, the optimal inheritance tax rate might be as large as 50%–60%—or even higher for top bequests, in line with historical experience.