Just after the 2001 tax bill was enacted, I noted that the estate tax would be repealed “only for one year (2010). In that same year, assets would begin to be inherited at their purchase price rather than market value (carryover basis), so heirs would inherit old capital-gains tax liabilities. … If carryover basis were maintained after 2010 … then heirs could end up brutally taxed on both the value of inherited assets and old gains on those assets.”
A Wall Street Journal fact-checker called, thinking I surely must have made a mistake. But Congress made the mistake and has to fix it.
There are not enough Senate votes for repeal, so the debate is now down to choosing between a 45-55 % tax rate with a hypothetical $10 million exemption or Republican Sen. Jon Kyl’s plan of a 15% tax rate with a $3.5 million exemption.
Washington Post writers Jeff Birnbaum and Jonathan Weisman put too much spin on this, putting economics aside and depicting it as nothing more than a contest between the very wealthy (who would pay zero estate tax with a huge exemption), and the extremely wealthy (some of whom might pay less with a lower rate, despite the smaller loophole). They did note, however, that the estate-planning industry is lobbying hard against a 15% estate tax, which would kill its costly tax-avoidance schemes.
For the few who might put economics before politics, this is no contest. Combining huge loopholes with high marginal tax rates is the textbook definition of a foolish tax — one that maximizes economic distortions while minimizing revenue.
Meanwhile, as I warned in 2001, New York Times writer Edmund Andrews is pretending it is a “strange wrinkle” that Kyl would not combine carryover basis with the estate tax — something that has never been done because it would tax both the entire value of inherited assets plus any past gains on those same assets.
Birnbaum and Weisman cite the “nonpartisan” Tax Policy Center, three members of which (Len Burman, Bill Gale and Jeff Rohaly) recently argued: “Repeal would be expensive. … Making repeal permanent as of 2010 would cost $270 billion in the next 10 years. Repeal would also be regressive (and) would reduce charitable giving by more than $15 billion a year.”
On the first point, the alleged revenue loss from scrapping the estate tax — $27 billion a year after 2010 — would amount to only .007 (seven thousanths) of one percent of total revenue, estimated at $3.8 trillion by 2015. Alicia Munnell, an economist with the Clinton Treasury, estimated the cost of collecting the estate tax is as large as the amount collected.
These trivial estimates of revenues lost by scrapping the estate tax are static — they “do not account for behavioral response.” Yet we must consider the impact of the estate tax planning on: (1) income tax receipts, and (2) investment and entrepreneurship.
In 1987, a study in Tax Policy and the Economy by Douglas Bernheim of Stanford concluded that “available evidence suggests that, historically, true revenues associated with estate taxation may well have been near zero, or even negative.” The estate tax results in lower income taxes through such means as giving stocks and bonds to heirs in lower tax brackets, funding M.D. degrees for grandchildren, deducting tax-avoiding life insurance premiums from business income and setting up tax-exempt foundations.
Supply-side effects make it even less likely that the estate tax raises any revenue. As a July Congressional Budget Office (CBO) study notes, an estate tax can “lead people to invest less than they would otherwise” and “reduce entrepreneurial efforts.”
Any claim that repeal of the estate tax would be “regressive” assumes the tax is harmless. On the contrary, as Joseph Stiglitz explained in “Notes on the Estate Tax” in 1978, “reductions in savings and capital accumulation will, in the long run, lead to a lower capital-labor ratio; and the lower capital-labor ratio will … lead to an increase in the share of capital. Since income from capital is more unequally distributed than is labor income, the increase in the proportion of income accruing to capital may increase the total inequality of income.”
Gale, Burman and Rohaly imagine that total repeal of the estate tax would have a “devastating” effect on charitable giving. They cite an unofficial paper by CBO economists who sought a diplomatic compromise between conflicting estimates by Gale and a Treasury economist, concluding that an estate tax of zero might have trimmed charitable giving by $14 billion (it was $249 billion in 2004).
In a 1997 study for the Philanthropy Roundtable, “Death, Taxes and the Independent Sector,” I observed that charitable giving rose by a record 28% in real terms from 1982 to 1989, after the highest tax rate was cut from 70% to 28% on income and from 70% to 50% on estates.
In fact, charitable giving has long been a surprisingly constant share of income, whether tax rates rose or fell. Giving was 2.3% of GDP in 1973, when the top income tax was 70%, 2.3% in 1989, when the top tax was 28%, and 2.3% in 2003, when the top tax was 35%.
I also found, however, that differences between tax rates on income, estates and capital gains did indeed affect the timing and form of charitable contributions. Income tax rates were much lower than estate tax rates after 1986, and that wider gap reduced the relative value of charitable tax deductions for giving during life, compared with tax advantages of bequests and foundations after death.
The increased capital gains tax from 1987 to 1996 also discouraged asset sales before death, further delaying the timing of charitable giving. The 1986 alternative minimum tax on gifts of appreciated property (except to foundations) further favored foundations over charities.
“In addition to altering the timing and form of charitable contributions,” I wrote in Philanthropy, “estate taxes affect work and saving habits in ways that have important consequences for income and, as a consequence, for philanthropy. The estate tax discourages the accumulation of assets beyond the exempt amount. This makes capital more scarce than otherwise, slowing the growth of productivity and real wages. Reducing or eliminating the death tax, accordingly, would provide greater incentives to accumulate larger estates. The result would be a larger national capital stock and a larger future flow of capital income to be used for all purposes — including charities.”
All the self-interested and ideological efforts to rationalize high tax rates on estates are as indefensible as were similar efforts to rationalize higher tax rates on dividends. Because we have a tax on capital gains, it makes sense to impose the same tax rate on estates to avoid distorting the timing of asset sales.
Any estate tax higher than the tax on capital gains is socially counterproductive, hurting the economy and overall tax receipts, while benefiting nobody except estate-tax planners.