What's All the Fuss about the Death Tax?
THE FOLLOWING COMMENTARY WAS DELIVERED BY MICHAEL MEEROPOL OVER WAMC RADIO IN SEPTEMBER OF 2008
A public relations coup occurred recently. The estate tax has been reincarnated as the death tax. Though this tax is levied on only 2% of the population, millionaires and billionaires, it is one of our most unpopular taxes.
How is it a death tax? Consider the income or payroll tax. One reduces your income. The other reduces your wages. And what does the death tax reduce? What you keep after dying? Are there IRS agents taking a cut as you enter the pearly gates?
The so-called death tax is actually a tax on the value of assets – the estate – left by someone who dies. Those paying the tax are very much alive – they are the heirs.
And – they only have to pay the tax if the estate’s total value is greater than $2,000,000.
What are the pros and cons of such a tax? [1]
First of all the government needs to raise revenue. The estate tax is an almost perfect example of a tax based on ability to pay. What that means is that the people paying the tax can most afford to pay it.[2]
Suppose I were the grand-child of a very rich person. I might be earning $30,000 a year, I might be earning $300,000. I might be earning no income at all. Whatever my income, it is a fact that exists before I get my share of my grandparent’s estate.
Suppose the estate is $3 million. The tax is levied only on the $1 million over and above the $2 million exemption. The tax rate is 45%. The estate loses $450,000 to the IRS reducing it to $2,550,000. If I share with nine other people, I will get $255,000.
My annual income has not been reduced. No harm has been done to me by the tax. It was never my money – it belonged to my grandfather and just landed on me because he died.
According to one estimate, the estate tax would raise $39 billion in 2011 if the law reverted to 2001 rules and $29 billion if the exemption stayed at $2 million.
This is not a lot of revenue when you consider the federal budget will exceed $3 trillion by 2001. However, for every dollar of reduced taxes, someone else has to pay higher taxes or some government service has to be reduced or more revenue has to be borrowed. In other words, there is some impact.
Some have argued that the existence of the estate tax discourages individuals from making investments and building up an estate because they know their heirs won’t get all of it. This argument seems nonsensical to me. Even at a tax rate of 45%, the heirs get to keep 65 cents for every dollar left by grandpa. (after paying nothing on the first $2 million).
Actually, the existence of that tax often convinces wealthy people to donate some of their wealth to non-profit organizations. Wealthy families often create tax-exempt foundations and make donations to colleges and universities. Such contributions reduce the estate tax burden while creating institutions that outlive the founders – think of the Rockefeller and Ford Foundations or Carnegie Mellon University.
A little understood effect of abolishing the estate tax is that it would be terribly destructive of the incentives and self-reliance of those heirs who receive a millions of dollars in inheritance. Pundits and politicians worry about the bad incentives created by our public welfare system – the willingness to work hard is virtually destroyed by the thousand dollars given to poor women with children to just “sit around” and allegedly “don’t work…”
Imagine the disincentive to work or achieve anything if you know from the time you’re born that you’re going to inherit over a million dollars from grandpa. The estate tax reduces that serious disincentive as grandpa gives a lot away and the government takes 45% over $2 million.
The estate tax – we should keep it.
1. For a good summary of the issues relating to the estate tax see the following: “Options to Reform the Estate Tax” by Leonard Burman, William Gale and Jeffrey Rohaly Tax Policy Issues and Options (Urban-Brookings Tax Policy Center) No. 18 March, 2005. It is available on the web at: http://taxpolicycenter.org/publications/template.cfm?PubID=9218
In 2001, President Bush’s first tax cut was passed by Congress. One of its most significant provisions was the phase out of the estate tax. In 2001, the top rate of taxation was 55% and the exemption was less than $1 million. For 2007, 8 and 9, the exemption is set at $2 million with a rate of taxation not to exceed 45%. In 2010 unless the law is changed before then, the estate tax will disappear. However, in order not to appear to be losing the Treasury too much money over the ten years after the 2001 tax cut was passed, Congress provided for the estate tax to return with the exemption at $1 million and the top rate back up to 55% in 2011 (prompting many jokes about people killing off their rich elderly relatives in 2010). It is clear that some compromise will occur so as to create some estate tax with an exemption higher than $1 million before 2010 – though perhaps that one year window without an estate tax will occur with the compromise coming in 2011 to avoid a big increase in the burden. For a brief discussion of different perspectives on the estate tax – and how the idea of calling it a “death tax” caught on – see, C. Eugene Steuerle Contemporary US Tax Policy (Washington, DC: The Urban Institute Press, 2004).
2. There are two basic principles of taxation: One is the so-called benefit principle which attempts to levy a tax so that those that benefit from the government services provided end up paying for the tax. A good example of this tax is the gasoline tax though it is rather imperfect. The tax on the gallons of gasoline you burn in your car is held in a fund to build and maintain highways. The reason it’s an imperfect tax on the benefit one derives from driving is cars have different gasoline mileage. Also, different sized cars have different impacts on the roads. Finally, the benefits of driving cannot be measured by the number of miles one drives. Driving to work has a much higher intensity of benefit associated with it than driving for pleasure. If you stopped driving for pleasure you might be less happy. If you stopped driving to work you’d have a significant reduction in income. The second principle of taxation is called the ability-to-pay principle. Since most government programs do not provide specific services which individuals can “consume” and attempt to measure their personal satisfaction from (as one might do in driving down a highway) it is often impossible to calculate the “benefit” that accrues to this person as opposed to another. (How could I quantify the benefit I get from the existence of the Federal Aviation Administration or the National Parks Service or the Postal Service or the Coast Guard?) Thus, the alternative method of calculating the appropriate tax is based solely on the ability of the taxpayer to pay. Using this principle, the tax should be levied either on a person’s income, wealth or (according to some) consumption. In addition, there is a strong preference for taxes that provide an exemption for certain levels of income, wealth and/or consumption from taxation. The idea here is that if you have a low income or low consumption, all of it is being spent on necessities and it would actually create real hardship to take some of that away. Once one has agreed that some level of income, consumption or wealth should be taxed at a zero rate, then the positive rate on the amount over the exemption means that you have favored a progressive tax system where the higher your income, the higher the RATE at which you are taxed. If there is agreement on this point, there is a significant debate as to whether rates should escalate as incomes get even higher or should stay at the same fixed level once the income exempt from taxation (taxed at a zero percentage rate) has been exceeded. For a discussion of a number of these issues see Steuerle: ch. 2. On the income vs. consumption taxation, see Economic Report of the President, 2004, ch. 6.
A public relations coup occurred recently. The estate tax has been reincarnated as the death tax. Though this tax is levied on only 2% of the population, millionaires and billionaires, it is one of our most unpopular taxes.
How is it a death tax? Consider the income or payroll tax. One reduces your income. The other reduces your wages. And what does the death tax reduce? What you keep after dying? Are there IRS agents taking a cut as you enter the pearly gates?
The so-called death tax is actually a tax on the value of assets – the estate – left by someone who dies. Those paying the tax are very much alive – they are the heirs.
And – they only have to pay the tax if the estate’s total value is greater than $2,000,000.
What are the pros and cons of such a tax? [1]
First of all the government needs to raise revenue. The estate tax is an almost perfect example of a tax based on ability to pay. What that means is that the people paying the tax can most afford to pay it.[2]
Suppose I were the grand-child of a very rich person. I might be earning $30,000 a year, I might be earning $300,000. I might be earning no income at all. Whatever my income, it is a fact that exists before I get my share of my grandparent’s estate.
Suppose the estate is $3 million. The tax is levied only on the $1 million over and above the $2 million exemption. The tax rate is 45%. The estate loses $450,000 to the IRS reducing it to $2,550,000. If I share with nine other people, I will get $255,000.
My annual income has not been reduced. No harm has been done to me by the tax. It was never my money – it belonged to my grandfather and just landed on me because he died.
According to one estimate, the estate tax would raise $39 billion in 2011 if the law reverted to 2001 rules and $29 billion if the exemption stayed at $2 million.
This is not a lot of revenue when you consider the federal budget will exceed $3 trillion by 2001. However, for every dollar of reduced taxes, someone else has to pay higher taxes or some government service has to be reduced or more revenue has to be borrowed. In other words, there is some impact.
Some have argued that the existence of the estate tax discourages individuals from making investments and building up an estate because they know their heirs won’t get all of it. This argument seems nonsensical to me. Even at a tax rate of 45%, the heirs get to keep 65 cents for every dollar left by grandpa. (after paying nothing on the first $2 million).
Actually, the existence of that tax often convinces wealthy people to donate some of their wealth to non-profit organizations. Wealthy families often create tax-exempt foundations and make donations to colleges and universities. Such contributions reduce the estate tax burden while creating institutions that outlive the founders – think of the Rockefeller and Ford Foundations or Carnegie Mellon University.
A little understood effect of abolishing the estate tax is that it would be terribly destructive of the incentives and self-reliance of those heirs who receive a millions of dollars in inheritance. Pundits and politicians worry about the bad incentives created by our public welfare system – the willingness to work hard is virtually destroyed by the thousand dollars given to poor women with children to just “sit around” and allegedly “don’t work…”
Imagine the disincentive to work or achieve anything if you know from the time you’re born that you’re going to inherit over a million dollars from grandpa. The estate tax reduces that serious disincentive as grandpa gives a lot away and the government takes 45% over $2 million.
The estate tax – we should keep it.
1. For a good summary of the issues relating to the estate tax see the following: “Options to Reform the Estate Tax” by Leonard Burman, William Gale and Jeffrey Rohaly Tax Policy Issues and Options (Urban-Brookings Tax Policy Center) No. 18 March, 2005. It is available on the web at: http://taxpolicycenter.org/publications/template.cfm?PubID=9218
In 2001, President Bush’s first tax cut was passed by Congress. One of its most significant provisions was the phase out of the estate tax. In 2001, the top rate of taxation was 55% and the exemption was less than $1 million. For 2007, 8 and 9, the exemption is set at $2 million with a rate of taxation not to exceed 45%. In 2010 unless the law is changed before then, the estate tax will disappear. However, in order not to appear to be losing the Treasury too much money over the ten years after the 2001 tax cut was passed, Congress provided for the estate tax to return with the exemption at $1 million and the top rate back up to 55% in 2011 (prompting many jokes about people killing off their rich elderly relatives in 2010). It is clear that some compromise will occur so as to create some estate tax with an exemption higher than $1 million before 2010 – though perhaps that one year window without an estate tax will occur with the compromise coming in 2011 to avoid a big increase in the burden. For a brief discussion of different perspectives on the estate tax – and how the idea of calling it a “death tax” caught on – see, C. Eugene Steuerle Contemporary US Tax Policy (Washington, DC: The Urban Institute Press, 2004).
2. There are two basic principles of taxation: One is the so-called benefit principle which attempts to levy a tax so that those that benefit from the government services provided end up paying for the tax. A good example of this tax is the gasoline tax though it is rather imperfect. The tax on the gallons of gasoline you burn in your car is held in a fund to build and maintain highways. The reason it’s an imperfect tax on the benefit one derives from driving is cars have different gasoline mileage. Also, different sized cars have different impacts on the roads. Finally, the benefits of driving cannot be measured by the number of miles one drives. Driving to work has a much higher intensity of benefit associated with it than driving for pleasure. If you stopped driving for pleasure you might be less happy. If you stopped driving to work you’d have a significant reduction in income. The second principle of taxation is called the ability-to-pay principle. Since most government programs do not provide specific services which individuals can “consume” and attempt to measure their personal satisfaction from (as one might do in driving down a highway) it is often impossible to calculate the “benefit” that accrues to this person as opposed to another. (How could I quantify the benefit I get from the existence of the Federal Aviation Administration or the National Parks Service or the Postal Service or the Coast Guard?) Thus, the alternative method of calculating the appropriate tax is based solely on the ability of the taxpayer to pay. Using this principle, the tax should be levied either on a person’s income, wealth or (according to some) consumption. In addition, there is a strong preference for taxes that provide an exemption for certain levels of income, wealth and/or consumption from taxation. The idea here is that if you have a low income or low consumption, all of it is being spent on necessities and it would actually create real hardship to take some of that away. Once one has agreed that some level of income, consumption or wealth should be taxed at a zero rate, then the positive rate on the amount over the exemption means that you have favored a progressive tax system where the higher your income, the higher the RATE at which you are taxed. If there is agreement on this point, there is a significant debate as to whether rates should escalate as incomes get even higher or should stay at the same fixed level once the income exempt from taxation (taxed at a zero percentage rate) has been exceeded. For a discussion of a number of these issues see Steuerle: ch. 2. On the income vs. consumption taxation, see Economic Report of the President, 2004, ch. 6.
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