Why Death Taxes Should Be Abolished

Policy Backgrounders | Taxes

No. 150
Wednesday, August 18, 1999
by Bruce Bartlett

Why the Very Rich Pay Less

Figure II - Estate Taxes as a Share of Gross Estate%2C 1995

A fundamental rationale for the estate tax is that it is paid only by those who can most easily afford it; namely, the rich. However, because of legal estate planning techniques, much less of the tax actually falls on the very wealthy than is commonly believed.

  • In 1995, 52 percent of all estate tax revenue came from estates under $5 million.
  • As Figure II illustrates, estate taxes as a share of gross estates actually fall for those with estates above $20 million.

"The lawful methods of avoiding the estate tax make it essentially a voulentary tax."

The reason for this disparity is that careful estate planning can virtually eliminate the tax. At the simplest level, individuals can give away up to $10,000 per year per person free of gift tax. Also, there is a large deduction for gifts made to spouses, whose estates may be taxed separately. Thus for most married couples, the estate tax only applies to estates larger than $1.3 million. Beyond that, there are a number of increasingly complex methods for reducing the burden of the estate tax. They include:

  • Life insurance trusts.
  • Qualified personal residence trusts.
  • Charitable remainder trusts.
  • Charitable lead trusts.
  • Generation-skipping trusts.7

One indication of the growth of estate planning is the increase in the share of total estate and gift taxes being raised by the gift tax, as shown in Table I. By making gifts of stock or other assets during their lifetimes, any subsequent increase in their value will no longer be part of the estate.

"A disproportionate burden of the estate tax often falls on those with recently aquired, modest wealth: farmers, small businessmen and the like."

So effective are these methods of avoiding estate taxes that Professor George Cooper of Columbia University says that the estate tax essentially is a voluntary tax. As he wrote, "The fact that any substantial amount of tax is now being collected can be attributed only to taxpayer indifference to avoidance opportunities or a lack of aggressiveness on the part of estate planners in exploiting the loopholes that exist."8 Economists Henry Aaron and Alicia Munnell put it even more bluntly. In their view, estate taxes aren't even taxes at all, but "penalties imposed on those who neglect to plan ahead or who retain unskilled estate planners."9

Table I - Estate and Gift Tax Revenues

However, as Figure II makes clear, the ability to exploit existing tax-avoidance techniques is not uniform across estates. Those with the largest estates clearly have the greatest ability to engage in estate planning. This is because many estate planning techniques are costly and require long lead-times to implement. And families with long histories of wealth are more likely to be familiar with them. Thus a disproportionate burden of the estate tax often falls on those with recently acquired, modest wealth: farmers, small businessmen and the like. In many cases their incomes may not have been very high and they died not even realizing that they were "rich."

The reason those with larger estates are more likely to engage in complex estate planning is, of course, that they pay higher marginal tax rates on their assets. However, the same general principle applies to the estate tax in general. Research shows that during periods when estate tax rates were rising, revenue from the estate tax fell. Conversely, lower estate tax rates increased estate tax revenue, because it was no longer as profitable to engage in costly estate planning.10 Estate planning is costly, not just in terms of lawyers fees and the like, but also because assets placed in trust may not earn as high a rate of return as they would under the original owner's control.11

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