New Report on the Federal Estate Tax
June 2, 2006
In anticipation of the Senate vote next week on whether to repeal or reform the federal estate tax, we’ve released a new “Special Report” examining the economics of the estate tax, as well as an overview of its 90-year history. From the executive summary:
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, both arguments rely on questionable assumptions. First, 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 income and wealth redistribution. Second, the history of the federal estate tax makes clear that the tax has never been an important federal 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 even negative net tax revenue once widespread estate-tax avoidance is accounted for.
This report provides an overview of two other well-researched aspects of the estate tax as well: its effect on entrepreneurship, and its high costs of compliance. Previous Tax Foundation research has found the estate tax acts 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. Economic studies estimate the compliance costs of the federal estate tax to be roughly $1 for every dollar 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.