The death tax is counterproductive because:
A. It is less progressive than income taxes.
B. It favors consumption, rather than savings.
C. It places disproportionate burdens on groups that should not be burdened.
1. The death tax is particularly hard on women. Surviving spouses are more likely to be women than men. Women pay a greater percentage of estate taxes than do men.
2. The death tax favors highly educated technical and professional workers, over less educated, but more entrepreneurial businesspeople. The educated leave bequests to their children in the form of advanced education, while the business-oriented leave bequests to their children in the form of business assets. Public policy should not tax the bequests of independent businesses, and subsidize the bequests of the professional classes.
3. The death tax benefits corporations, which have no death date, at the expense of family businesses, which face the tax upon the death of the owner.
D. The death tax is not particularly needed for breaking up dynastic wealthy families, since they tend to break up on their own.
Congress should take steps to eliminate the death tax permanently, including:
–Phase out the death tax rates at a faster rate.
–Do not reimpose the death tax, as currently scheduled.
–Reduce the rates.
–Raise the level of income at which the tax applies.
WHY THE DEATH TAX IS COUNTERPRODUCTIVE
The federal estate tax, commonly called the death tax, is slated to be phased out by the year 2010. Unfortunately, due to the incoherence of political logrolling, the tax will return in full force the following year. This bizarre tax schedule makes responsible estate planning impossible. A person who dies January 1, 2011 will pay radically different taxes from someone who dies the previous day. The blatant injustice of levying radically different taxes on people who only differ in their date of death argues for creating a permanent and stable change in the estate tax structure. According to Kevin Hassert of the American Enterprise Institute, “anything can happen in ten years. Either the death tax will go away permanently, or it won’t go away at all.” This paper makes the case for making the phase out permanent, and even accelerating it.
The death tax is counterproductive for four major reasons. First, taxes levied at death are less progressive than taxes levied during life. If policy makers want a progressive tax system, they should scrap the death tax. Second, the death tax tends to encourage consumption and discourage savings. Encouraging savings and wealth accumulation provides the most stable basis for long-term economic growth. Third, the death tax places disproportionate burdens on groups that should not be burdened. Women pay larger percentages of estate taxes than do men. The death tax hits family and small businesses particularly hard. Finally, the estate tax does not prevent dynastic families from developing, since most family financial dynasties tend to break up on their own.
Thus, every legitimate objective that the estate tax might meet could be better met by some superior policy. The estate tax has significant disadvantages over other sources of revenue. Therefore, phase out of the the death tax should made permanent, and even accelerated.
DISADVANTAGE #1: THE DEATH TAX IS LESS PROGRESSIVE THAN INCOME TAXES
Most policy makers profess to want a progressive tax structure, in which people with higher incomes pay larger marginal percentages of their income in taxes. Wealthier people have more money and are better able to pay. This arrangement strikes most people as intrinsically fair.
The death tax fails the test of progressivity, even though the legislated marginal tax rates rise with the size of the estate. People with the largest estates are the most likely to expend resources for estate planning and thus lower the percentage of their estate actually paid in taxes. The major costs of tax avoidance strategies are the investment of time and energy learning about the law, finding compentent professional help and so on. Once a person has figured out the basic strategies, the cost of implementing those strategies do not increase very much with the size of the estate. People with large estates have more at stake in learning about tax avoidance strategy, so they bear those large initial costs. People who accumulate large amounts of wealth also tend to be among the more financially sophisticated.
For these reasons, heirs of smaller estates actually lose a higher percentage of their inheritances to the death tax than do those with larger estates. In fact, the effective estate tax rate actually falls for estates above $20 million, to about 12% of the total value of the estate. By contrast, estates valued between 2.5 million and 5 million paid close to 15%, and estates between 5 and 20 million paid nearly 18% of the total value of their estate in taxes.
The federal income tax is more progressive than the estate tax. The top1% of the income earners paid 36% of the total income taxes, while the top 5% of the income earners pay over half of all the income taxes. In 1997, more than 50 percent of all estate tax revenue came from estates under $5 million. But less than 4% of the income tax revenue came from the bottom 50% of the income earners. A recent study estimates that two-thirds of the wealth of the nation’s richest families goes untaxed.
Therefore, if policy makers want to have a tax code that is progressive overall, they would be well advised to rely on the income tax, and phase out the estate tax. The income tax is a more effective tool for redistributing income from the high income earners to lower income earners.
DISADVANTAGE #2: THE ESTATE TAX ENCOURAGES CONSUMPTION, AND DISCOURAGE SAVINGS AND INVESTMENT
Savings and investment are the engines of sustainable economic growth. Policies that actively encourage savings and investment are therefore more desirable than policies that encourage consumption, particularly frivoulous consumption. The death tax, is counterproductive because it discourages savings and investment and encourages consumption.
Wealth and income are two different things. Wealth refers to accumulated capital. A person typically accumulates wealth by spending less than their income, year in and year out, and making wise investments along the way.
The income tax structure taxes higher incomes at higher marginal rates. In this sense, the tax code considers people with high incomes to be “rich.” This seems fair, since even after paying taxes, a person with a high income can probably still set aside something toward savings.
The death tax taxes accumulated wealth, regardless of how it was acquired. The death tax makes no distinction between a million dollar estate built up from a lifetime of savings and a million dollar estate that consists only of the appreciated value of one trophy home owned by a highly paid professional. Yet one estate required far more discipline and frugality to acquire. At the very least, the tax code should not discourage this kind of focused wealth accumulation.
Dr. Thomas Stanley draws a distinction between the “Balance Sheet Affluent,” and the “Income Statement Affluent,” to call attention to this difference in economic productivity. Many people with high incomes throughout their lifetimes, do not accumulate as much wealth as their lifetime income would suggest. On the other hand, some with far less education, and initial incomes manage to accumulate substantial wealth in one generation. These “Prodigious Accumulators of Wealth” are what Dr. Stanley calls “The Millionaire Next Door.” The estate tax penalizes these people for a lifetime of hard work and savings, the very virtues upon which a thriving market economy depends.
This is particularly important since the amount of wealth a person accumulates over a lifetime depends primarily on the percentage of their incomes they choose to save. The decision to save is far more important in wealth accumulation than lucky breaks, such as a large inheritance, exceptional investments or even the level of earnings. This means that even families of modest means can accumulate substantial wealth through a lifetime of thrift. Taxing these people’s heirs at death seems particularly perverse.
In addition, the death tax encourages families to spend their wealth, or accumulate less in the first place, simply to lower their top marginal tax rates. One study found that the estate tax prevailing when the taxpayer is 45 years old or ten years before death, has a negative impact on the size of the estate the person ultimately accumulates. In fact, the tax rate that prevails at this earlier age has a more significant impact on wealth accumulation than does the tax rate actually in place at the time of death. Thus, the estate tax discourages savings, not just in the period immediately prior to death, but throughout the life cycle. October 2000.
DISADVANTAGE #3: THE DEATH TAX PLACES BURDENS ON GROUPS THAT SHOULD NOT BE BURDENED
The exact burden of the estate tax is difficult to determine because the tax is paid by the heirs, not the donor. A person who accumulates substantial wealth may choose to bequeath it to a less wealthy heir, who is ultimately responsible for paying the tax. We can make a few generalizations about the incidence of this tax, however.
Women pay a disproportionate share of estate taxes. Women on average outlive their spouses. While women accounted for only 45 percent of estate tax filers in 1995 and owned only 40 percent of the value of estates, they paid 55 percent of all estate taxes collected. Of men who died with sufficient assets to owe estate taxes, 65 percent were married and their heirs paid the government an average tax of $70,000. By contrast, 62 percent of women who died with such asset levels were widows and their families’ average tax bill was $294,000 — a difference of $224,000. As a result, women are often advised to spend their wealth so as to avoid the higher estate tax brackets.
The death tax also tends to favor more educated, professional classes, at the expense of more working class families. Highly educated professionals tend to bequeath their children advanced education, to prepare them to earn high incomes. Many of the “millionaires next door,” however, are people of modest educational backgrounds, who are more likely to leave the heirs a share of a thriving business. The tax code does not tax education, the preferred bequest of one class, but it does tax business and capital assets. It makes more sense to tax income when it is earned, than to try to redistribute income by taxing some kinds of bequests.
Finally, the death tax falls more heavily on small businesses than on corporations. In every generation, when the owner of a small or family business dies, his heirs must pay taxes on the value of the enterprise. Publicly held corporations do not face this tax because the corporation has no death date. The heirs of many farmers, ranchers and small business owners must liquidate their businesses, just to pay the estate taxes. Nearly 90 percent of family-owned businesses do not survive past a second generation due to the need to sell off assets to pay this tax. One survey found 51% percent of family businesses would have significant difficulty surviving in the event of a principal owner’s death, due to the estate tax, while another 14 percent of businesses said it would be impossible for them to survive. Thus, the estate tax penalizes small and family-owned businesses with a tax that corporations never face.
DISADVANTAGE #4: THE DEATH TAX DOES NOT INHIBIT THE FORMATION OF FAMILY DYNASTIES
One argument in favor of the death tax is that it is a necessary tool for breaking up wealthy, dynastic families. Without a death tax of some sort, a wealthy family could enrich its offspring, who in turn can accumulate large amounts of wealth to pass on to their heirs. This argument is based on speculation, not facts. Most wealthy families break up on their own, and inheritance makes an insignificant contribution to the wealth of most of the truly wealthy.
On the first point: a recent study shows that wealth “churns” over time. That is, those who are wealthy in one period are not necessarily wealthy ten years later, and vice versa. Specifically, a comparison of families between 1966 and 1976 found that 35.5 percent increased by at least one decile of wealth (one-tenth) and 18 percent moved up at least 2 deciles. Over the same period, 34.6 percent moved down at least one decile and 17.9 percent moved down at least 2 deciles. Another study of families between 1984 and 1994 found 60 percent of families in the bottom decile of wealth the first year had reached a higher decile 10 years later. Of these, an amazing 23 percent went up four or more deciles, with 1.42 percent rising from the lowest decile to the highest. At the same time, about 10 percent of those in the highest decile of wealth fell more than three deciles and a few ended up all the way down in the bottom decile.
On the second point, inheritance contributes only a small amount to the overall wealth of those who are truly affluent. Among the top 5 percent of households ranked by wealth, inheritances accounted for less than 8 percent of assets. A recent study of U.S. millionaires found that 80 percent acquired their wealth in a single generation, without the benefit of inheritances. U.S. Trust Corporation surveyed the wealthiest 1 percent of Americans and found that inheritances were a significant source of wealth for only 10 percent of respondents. Earnings from a privately owned business was by far the dominant source of wealth, accounting for 46 percent.
Thus, the inheritance tax is not needed to prevent mass accumulations of wealth within families. The heirs of wealthy families are capable of dissipating their own fortunes, without any prodding from government. People who accumulate wealth seldom rely heavily on inheritance for a significant portion of their wealth.
The estate tax does not meet the objectives it advocates claim for it. The estate tax is less progressive than the income tax code. The death tax encourages consumption and inhibits wealth accumulation. The death tax falls disproportionately on women, entrepreneurs and owners of family businesses. The death tax priveleges education bequests while taxing business and financial bequests. The death tax benefits large corporations, which have no death date, at the expense of family businesses. And the death tax is not needed to prevent the accumulation of wealthy dynastic families.
Every legitimate objective of the estate tax could be met by other policies. Therefore, the phase out of the estate tax should be accelerated, and made permanent.