September 19, 2010

The Estate Tax Is Foolish, Wasteful, Ineffective

This op-ed was published in the Richmond Times-Dispatch on Sept. 19, 2010.

Washington, D.C. — People are supposed to become more popular when they die, but Yankees owner George Steinbrenner and Houston oilman Dan Duncan both became targets of political invective for being billionaires who died during 2010, the only year since 1916 when no federal estate tax is due.

Virginia billionaire John Kluge has been spared by tax-envious pundits and has gotten the rave reviews he deserves since his recent death at his home in Albemarle County.

Kluge had donated more than $63 million to the University of Virginia during his lifetime, and the college will also receive his Albemarle estate, valued at $45 million in 2001.

Thanks to the Bush tax cuts enacted a decade ago and a disorganized Democratic Congress at the end of 2009, the heirs of all three of these titans are spared the monumental chore of filing a federal estate tax return and paying up to 45 percent of the estate in tax (the top rate in 2009).

There will still be a minefield of estate tax complexity for them to navigate, made worse by the temporary nature of the repeal, but they can avoid the tax unless Congress acts in the next few months to apply the estate tax law retroactively to all of 2010. That is the intention of Max Baucus, chairman of the Senate Finance Committee, and the Obama administration.

The executors and heirs would be better off if the repeal had been permanent, and here’s a surprise: so would every other taxpayer. Why?

Not just because of the usual anti-“death tax” talking points: that it can prevent small businesses and farms from being passed on to the next generation; and that it’s preposterously complex and economically damaging to savings and entrepreneurs.

In light of the federal government’s massive deficits, those arguments have not been enough to convince most congressmen to repeal the estate tax permanently.

But a paper by economist J.D. Foster has pointed out two other persuasive arguments for permanent repeal.

The estate tax siphons away income tax revenue.

Taxes are interactive. When Congress raises, lowers, or repeals one tax, it changes the revenue flows of the others. So even though the estate tax has been officially collecting about $25 billion a year in revenue, its repeal would not make such a big dent in federal coffers. The estate tax robs the income tax three ways:

• by shifting wealth into nonprofits that pay no tax;

• by boosting income tax deductions for tax planning; and

• by imposing wasteful compliance costs on taxpayers and the IRS.

Charities love the estate tax because most wealthy people would rather give their money away while they’re alive than leave it to Uncle Sam’s estate tax collectors. And while that sounds fine, those huge transfers sap income-tax revenue in the long run.

For example, consider a $100 million charitable gift made shortly before death in 2009 to avoid paying about $40 million in estate tax. The charity could be the National Rifle Association or Handgun Control, the Catholic Church or Planned Parenthood. If the charity invests the gift, it will earn about $8 million annually, tax-free.

But this year, thanks to estate tax repeal, people like Duncan, Steinbrenner, and Kluge are more likely to leave their assets in the hands of taxpaying people, probably their spouses and children, who continue earning taxable income. When the heirs earn that $8 million, it won’t be tax-free; they’ll pay about $3 million to Uncle Sam.

And if they reinvest the balance, 10 years of tax payments will exceed $40 million. After 20 years, the income tax payments would exceed $100 million.

So in this example, Uncle Sam gets more tax money from permanent repeal of the estate tax than he does from keeping it in law.

Permanent estate tax repeal would also boost income tax revenue by cutting back on tax planning, which is expensive and tax deductible. Wealthy individuals would shift their spending to non-deductible expenses or invest more, boosting current and future income-tax receipts.

Tax collectors would cheer, too. Not only would taxpayers avoid complex planning costs and massive paperwork, but the IRS could devote more collection efforts to areas that have historically been much more profitable.

We replace our wealthy families every year.

The estate tax supposedly cuts down on the concentration of wealth, and many people consider any tax on the nation’s wealthiest people, dead or alive, as the best sort of tax. But income inequality is, as even progressive economist Paul Krugman admits, not a big problem if Americans move rapidly up and down the income spectrum during their lifetimes.

Krugman doesn’t think our income mobility is adequate, but we do have a dynamic economy. The wealthiest people are almost never the same from year to year as new American entrepreneurs constantly emerge and soar past older fortunes.

IRS data back this up. The highest-earning 400 tax returns filed between 1992 and 2007 included only seven people who appeared continuously. One-timers were numerous: 2,515 people popped up into the top 400 once in that 16-year span.

One argument for permanent repeal, then, is that our dynamic economy has solved the concentration-of-wealth problem far better than the estate tax ever did or could.

Alas, this foolish tax is soon to be reinstated, possibly even retroactively. The tombstone should read “Federal Estate Tax, 1916-2009, RIP” but instead it will almost certainly rise from the dead and haunt our economy for many years to come.

William Ahern is director of policy and communications at the Tax Foundation, a nonprofit think tank in Washington, D.C. Contact him at