Wealth, Mobility, Inheritance And The Estate Tax

Studies | Taxes

No. 235
Thursday, June 01, 2000
by Bruce Bartlett


The Estate Tax

Figure III - Federal Tax Revenue%2C 2000

Although no serious effort has ever been made simply to ban inheritances, the government does make strenuous efforts to curtail them, mainly through the estate and gift tax.44

"The original purpose of the estate tax was revenue, not redistribution."

Early History. The estate tax is one of the oldest federal taxes. First imposed in 1797, its principal purpose was revenue, not redistribution. Hence, once the need for revenue fell, the tax was repealed in 1802. The tax was revived in 1862, again solely for revenue purposes. And as earlier, when the revenue requirement abated the tax was repealed in 1870. Another estate tax, imposed in 1898 to pay for the Spanish-American War, was abolished in 1902. The current estate tax dates from 1916, enacted to pay for World War I. This time, of course, it remained permanently.45

From Revenue to Redistribution. The original non-redistributive purpose of the current estate tax is shown by the fact that the initial top rate was just 10 percent. The estate tax did not become explicitly redistributive until the administration of Franklin Roosevelt. The Revenue Act of 1935, in particular, was almost solely concerned with redistribution. Roosevelt rationalized this policy as necessary to stave off even more redistributive proposals being propounded by Huey Long and others. To combat these "crackpot ideas," Roosevelt said, "it may be necessary to throw to the wolves the 46 men who are reported to have incomes in excess of one million dollars a year."46

The top estate tax rate, which was 45 percent when Roosevelt took office, was ratcheted up to 60 percent in 1934 and 70 percent in 1935. This and other provisions of the legislation designed to "soak the rich" were heavily criticized by economists as undermining business confidence and shifting the tax system away from its primary purpose of raising revenue.47 Nevertheless, it put the estate tax on a course from which it has never subsequently diverged.

"The estate tax contributes only 1.5 percent of total federal revenue."

Today the tax exists almost exclusively for redistributive purposes, since the revenue yield is minuscule. The estate and gift tax is the federal government's least significant revenue source. In fiscal year 2000 it is expected to raise just $30 billion, according to the Office of Management and Budget. With total federal revenues estimated at $2 trillion, the estate and gift tax contributes just 1.5 percent. [See Figure III.]

The current tax theoretically begins at a rate of 18 percent, and goes up to 55 percent. Taxpayers receive a credit of $220,550 on their estate tax liability. The effect of this is to ble estate is 37 percent. On estates between $10 million and $21 million the top rate actually is 60 percent, due to the phase-out of the unified estate and gift tax credit. This gives the U.S. the second highest top estate tax rate in the world; only Japan's 70 percent rate is higher.48 Interestingly, recent press reports blame Japan's high estate taxes for much of the sluggishness of its economy.49

"The burden of the estate tax falls primarily on the recipient, not the giver."

Burden of the Estate Tax. A fundamental justification for the estate tax is that it is paid only by those who can most easily afford it, namely the rich. This year, just 2.03 percent of adult deaths in the United States are expected to result in taxable estates.50 However, the burden of the tax falls primarily on the recipient, not the giver. For this reason, one cannot state with certainty what the distributional effect of the estate actually is, since heirs may be either wealthy or poor. This may be a sufficient reason to abolish the estate tax.51

The fact that the burden of the estate tax falls on heirs rather than decedents has important distributive implications. Generally speaking, heirs have less wealth and income than decedents. Hence, attributing the estate tax to the former rather than the latter would show the burden of the estate tax on those with middle incomes to be much higher than standard distributional tables indicate. Indeed, Congress's Joint Committee on Taxation has resisted inclusion of the estate tax in its distribution tables, owing to uncertainty about who actually bears the burden of the tax.52


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