The Case For The Tax Cut

Policy Reports | Taxes

No. 226
Sunday, August 01, 1999
by Bruce Bartlett

Death Tax Repeal

Figure VII - Taxes as a Share of Gross Estates%2C 1996

One of the main targets of the Clinton Administration's charge that the tax bill is unfair is its proposed elimination of the estate and gift tax - often called death taxes.10 The Treasury Department argues that the estate tax is necessary to maintain the overall progressivity of the tax code.11

But in reality, the estate tax does nothing to break up large fortunes and promote a more egalitarian distribution of wealth. Even liberal economists agree. Says Alan Blinder, a former member of Clinton's Council of Economic Advisers, "The reformer eyeing the estate tax as a means to reduce inequality had best look elsewhere."12 Indeed, despite the fact that the United States has one of the highest estate tax rates in the world, some economists believe that wealth has never been more unequally distributed than it is now.13

Ironically, the estate tax actually contributes to this maldistribution of wealth, rather than minimizing it. The reason is that careful estate planning can virtually eliminate the burden of the tax. So effective are these methods of avoiding estate taxes that Professor George Cooper of Columbia University says 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."14 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."15 (Munnell was a member of the Council of Economic Advisers under Clinton and Aaron served in the Carter Administration.)

Families with histories of great wealth are much more likely to engage in effective estate planning than those whose wealth is of more recent vintage. Also, many estate planning techniques require many years to implement, something more easily done by those born to wealth than those who made their own fortunes. As a consequence, the effective tax rate on estates over $20 million is actually lower than on those between $2.5 million and $5 million, as shown in Figure VII.

"The effective tax rate on estates over $20 million is lower than those between $2.5 million and $5 million."

Thus those who are paying the highest effective estate tax rates are not those with fortunes measured in nine, 10 or 11 digits, but those with modest wealth. These are often family farms and businesses that must be sold to pay the tax collector. Forcing such sales does nothing to equalize the distribution of wealth. Indeed, it fosters greater inequality by making it harder for those with small businesses to grow and become large. As a result, large, established firms are protected from competition and those who own them have an easier time maintaining their wealth.16

The economy as a whole and even the government also pay a price for the estate tax. According to economist B. Douglas Bernheim, the federal government raises no net revenue from the estate tax because many estate planning techniques also have the effect of reducing one's income tax liability. This loss of income tax revenue may offset all of the revenue the government gets from the estate tax.17

The government also loses revenue because the estate tax reduces economic growth, investment, new business formations and employment. For example:

  • A new survey of 365 family-owned businesses in New York found that they spent an average of $125,000 each on estate planning costs, reducing employment by more than 5,000 jobs.
  • In those 365 companies alone, the estate tax itself is expected to destroy ahan the business itself, which reduces growth and profitability.18

Surveys also indicate that many family-owned businesses devote more time to estate planning than the business itself, which reduces growth and profitability.19

"Those paying the highest rate often are family farms and businesses that must be sold to pay the tax collector."

A study by Congress's Joint Economic Committee concluded that the nation's capital stock is $497 billion smaller than it would be if there had been no estate tax over the last 20 years.20 Another study concluded that the estate tax is reducing economic growth by 0.4 percent and investment by 0.7 percent per year.21

For these reasons, leading economists and tax theorists have concluded that the estate tax has outlived its usefulness and should just be abolished. In the words of economist Douglas Holtz-Eakin of Syracuse University, "The direct empirical evidence to date suggests that the estate tax imposes a significant deadweight cost on the economy, fails to raise sufficient revenue to be considered a tool for income-distribution goals, and engenders considerable administrative and compliance costs. In short, the standard criteria of tax policy evaluation suggest that there is no reason to defend the estate tax."22

In recent years a number of major countries such as Canada, Israel and Australia have abolished their estate taxes. The U.S. should join them.

Read Article as PDF