Would Repealing the Estate Tax Really Hurt Tax Collections?

July 27, 2005

The drive to repeal the estate tax is close to success in the U.S. Congress, but it still may fall short. The two best arguments for repeal hinge on fairness and economic growth.

• For the sake of fairness, it should be repealed because its monstrous complexity favors vast family fortunes whose tax lawyers and accountants plan for decades to shield money from estate taxation. The losers in this game are small businesses and farmers whom death often catches legally unprepared.

• For the sake of economic growth, it should be repealed because it penalizes saving, and many economists believe it discourages new wealth creation by America’s most innovative, productive entrepreneurs.

On the other hand, there have always been two arguments in favor of the estate tax that have prevailed. One of them is obsolete.

For the sake of fairness, the estate tax was thought to prevent wealth from remaining concentrated in the hands of the same few families. Fortunately, the newly globalized economy generates vast amounts of new wealth and large numbers of newly rich people each year, solving the concentration-of-wealth problem more effectively than the estate tax ever could.

With all this against it, the estate tax has one last remaining ally, and that is the belief, supported by official estimates, that it brings a lot of money into the U.S. Treasury. In fact, it certainly does not raise nearly the money that the official estimates show. There are many complex tax-planning reasons why. Here are the three simplest:

1. Tax-exempt organizations have grown like weeds, crowding out taxable income. Most charities believe the estate tax boosts gift-giving as taxpayers try to avoid paying up to 55 percent of their accumulated savings to the federal government. These donations end up producing capital income for tax-exempt charities instead of taxable earnings for the donor.

For example, consider a $1 million charitable gift made to avoid estate tax. If the charity invests the gift and earns 8 percent annually, then it will earn $80,000 annually, tax free. If the estate tax were repealed, the donor would keep the million dollars or give it to a taxpaying heir. Either way, Uncle Sam would get between $12,000 and $28,000 in tax the first year, depending on how he invests. If the earnings are reinvested each year, then within 20 years the government would be out over a half million dollars in income tax revenue.

2. Estate planning is phenomenally expensive – and tax deductible. Official revenue estimates take no account of the enormous tax-deductible expenses incurred during estate planning. Absent the estate tax, these individuals would likely shift their estate planning money to non-deductible expenses, or they would save them. Either way, current or future income tax receipts would be higher.

3. Compliance costs for taxpayers and the IRS. Finally, if the estimators produced a truly comprehensive estimate for estate tax repeal, they would also account for the savings to the IRS which spends millions of dollars each year attempting to collect estate tax revenue. The resources devoted to estate tax compliance would likely be redirected into other areas of tax collection, areas which the estimators have historically scored as increasing collections significantly.

The estate tax is a levy without a mission. Its ill effects are legion, its social policy motivation obsolete, and even its revenue is an illusion. It should be repealed.

(Click here for more on estate and gift taxes.)


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