The Case for Abolishing Death Taxes
Table of Contents
Options for Reform
"Outright repeal is the best course, but it may not be politically feasible at this time."
Congress should consider these options:
Option 1. Repeal the estate and gift tax. Of course, outright repeal may not be politically feasible at this time. In that event, any of the efforts under way to reduce the estate tax by raising the exempt amount to $750,000 or $1 million merit support. Proposals that would target estate tax relief to family businesses, while worthy of support, are less desirable than repeal or increasing the exempt amount because they introduce further complexity to an already complex section of the Tax Code.
Option 2. Convert the estate tax credit to an exemption. This would reduce marginal estate tax rates for all estates under $3 million. Thus on the 600,001st dollar of taxable estate the tax rate would fall from 37 percent to 18 percent.
Option 3. Switch from an estate tax to an inheritance tax. Under the latter, estates would be taxed to the recipient, rather than in totality as at present. The virtue of this approach is that it actually would encourage wider distribution of wealth, because the tax would be lower when estates are broken up into a large number of pieces. To the extent that there is justification for using tax policy to prevent the concentration of wealth, this would work better than the current estate tax.30 This is the approach taken to transfer taxation by most other countries.31
Option 4. If it is necessary to raise alternative revenue to finance repeal of the estate tax, Congress might consider taxing capital gains at death instead. At present, the basis for all capital gains is stepped up at death. Thus capital gains held until death escape the capital gains tax altogether.32 The main problem with this is that it exacerbates the lock-in effect, which creates economic inefficiency.33 It means that new investments with greater growth potential are starved for capital because they are locked into older, underperforming assets that owners are reluctant to sell because of the capital gains tax. The result is that relative prices of capital assets are distorted, leading to the misallocation of investment. Taxing capital gains at death would raise as much or more revenue as the estate tax.34 This would create simplification by allowing one whole section of the Tax Code to be abolished, while lowering the top rate on assets held until death from 55 percent, the top estate tax rate, to 28 percent, currently the top rate on capital gains.
"A number of countries have already abolished the estate tax."
The estate tax is a bad tax. It raises little revenue. It does not redistribute wealth. It imposes large costs on the economy. And it is complicated and unfair. It should be abolished. In recent years a number of countries have done exactly that (see the Appendix). The United States should join them.35
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.
This Backgrounder is adapted from testimony June 12, 1997, before the Subcommittee on Tax, Finance and Exports of the U.S. House Committee on Small Business.