Death and Taxes: The Economics of the Federal Estate Tax
Special Report No. 142
In April 2005, the U.S. House of Representatives voted to permanently repeal the federal estate tax (H.R. 8). Similar legislation is currently pending before the U.S. Senate (S. 420), and lawmakers are expected to finalize this legislation soon. This Special Report provides a brief history of the federal transfer tax system, and briefly examines the economics of estate taxation.
The federal government taxes transfers of wealth in three ways: through the estate tax, the gift tax and the generation-skipping transfer tax. Together these taxes make up the federal transfer tax system. The modern estate tax was enacted in 1916, just three years after the federal income tax. Congress supplemented it with the gift tax in 1924 and again in 1932, and in 1976 enacted a generation-skipping transfer tax to curb tax avoidance through the use of trusts. Since 1976, the three-legged framework of the modern transfer tax system has remained essentially unchanged.
This report examines two common arguments in favor of estate taxation. First, estate taxes are commonly assumed to be borne by wealthy taxpayers. As a result, it is argued that they are an efficient mechanism to redistribute income within society. Second, it is commonly argued that estate taxes are an important federal revenue source, which should be maintained. However, once the tax-shifting behavior of estate holders is taken into account, the economic incidence of the estate tax may be much less progressive than is commonly assumed, making it a blunt instrument for wealth redistribution. Second, the history of the federal estate tax makes clear that it has never been an important revenue source, typically accounting for 1 to 2 percent of federal collections. A growing body of economic research suggests the tax may raise zero or negative net tax revenue once widespread estate-tax avoidance is accounted for.
Previous Tax Foundation research has found the estate tax acts as a strong disincentive toward entrepreneurship. A 1994 study found that the estate tax’s 55 percent rate at the time had roughly the same disincentive effect as doubling an entrepreneur’s top effective marginal income tax rate. The estate tax has also been found to impose a large compliance burden on the U.S. economy. Some past economic studies have estimated the compliance costs of the federal estate tax to be roughly equal to the amount of revenue raised—nearly five times more costly per dollar of revenue than the federal income tax—making it one of the nation’s most inefficient revenue sources.