Wealth, Mobility, Inheritance And The Estate Tax

Policy Reports | Taxes

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

Economic Impact

The estate tax also has a damaging effect on the national economy. It reduces saving, capital formation and therefore economic well-being. There is even academic evidence suggesting that the estate tax actually reduces federal revenue in the long run.

A Tax on Capital. With intergenerational transfers accounting for as much as 80 percent of the nation's capital stock, according to a study by Laurence Kotlikoff and Lawrence Summers,66 this means that the estate tax is a direct tax on capital. James Poterba estimates that the estate tax adds a tax of one to two percentage points to recipients of capital income.67 Therefore, it is reasonable to say that the nation's capital stock is reduced by at least the amount of the tax. The impact is even larger if it lowers the savings rate as well.68 And it almost goes without saying that the bulk of the nation's saving comes from those with upper incomes, those most likely to be affected by the estate tax.69

Of course, anything that reduces capital formation in the economy ultimately makes everyone poorer. That is why economists historically have warned against estate taxes:

  • Adam Smith: "All taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labor."70
  • David Ricardo: "It should be the policy of governments ... never to lay such taxes as will inevitably fall on capital; since by so doing, they impair the funds for the maintenance of labor, and thereby diminish the future production of the country."71
  • C.F. Bastable: "Succession duties first of all possess the grave economic fault of tending to fall on capital or accumulated wealth rather than on income; they therefore may retard progress."72

"Existing high estate tax rate do little to equalize the distribution of wealth."

Redistributive Effects. Ironically, the deleterious impact of the estate tax on saving and capital formation negates much of the redistributive effect of the tax. According to Joseph Stiglitz, to the extent that the estate tax lowers the capital stock it raises the return to the remaining capital.73 Since the rich already own most of the existing capital, the effect of the estate tax is actually to make them richer. Consequently, it is not surprising that existing high estate tax rates appear to do virtually nothing to equalize the distribution of wealth. As Alan Blinder observes, "estate taxation is not a very powerful weapon in the egalitarian arsenal....The reformer eyeing the estate tax as a means to reduce inequality had best look elsewhere."74

Dead Weight Losses. The estate tax also imposes large dead weight costs on the economy. First is the cost of employing large numbers of Internal Revenue Service agents to collect estate and gift taxes. Second is the cost of employing legions of tax lawyers to avoid the tax. Aaron and Munnell report that some 16,000 members of the American Bar Association cite trust, probate and estate law as their primary area of concentration. They conclude that compliance costs alone may eat up a sizable fraction of all estate tax revenues.75 Gerald Moran has suggested that the government may get more revenue from taxing the incomes of estate tax planners than from the estate tax itself.76

"It has been suggested that the government might get more revenue from taxing estate planners than from the estates themselves."

Effect on Federal Revenues. While expressing some skepticism about the magnitude of the effect Bernheim identifies, Edward McCaffery believes that the deleterious effect of the estate tax on federal revenues may even be larger for other reasons.77 In particular, he argues that the impact of the estate tax on economic growth may be significant, by reducing the incentive to work, save and invest. For example, he points out that if one's prime motivation is to leave a large estate to one's children, then the effective marginal tax rate on investment and labor is the income tax rate plus the estate tax rate. This rate can go as high as 73 percent at the federal level alone (39.6 percent top income tax rate plus 55 percent estate tax rate on the remainder), with state income taxes pushing it higher still. And McCaffery goes on to point out that these negative effects on saving and work effort are not limited to the very rich. Insofar as the estate tax encourages gifts to one's children during one's lifetime, it may have the effect of reducing their work and saving as well.

Few studies have looked at the macroeconomic effect of estate taxes. One that did concluded that repeal of the estate and gift tax would raise the level of GDP by 0.4 percent after five years. This is enough to raise federal revenues above the Congressional Budget Office baseline forecast.78 This implies that the federal government would on net gain - rather than lose - revenue if the estate tax were abolished.

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