Don’t Forget the Death Tax

The White House has submitted its budget to Congress, unveiling a $674 billion economic growth plan as well as new Lifetime Savings Accounts and Retirement Savings Accounts. President Bush has filled the void of domestic policy with one of the deepest tax cuts in recent years. Debate over the expansive plan has already begun and is expected to dominate much of Washington through the spring. Notable by its absence is the repeal of the death tax, an inefficient and unfair tax that should be stricken from the tax code.

Repeal of the death tax (more properly known as the estate tax) was first passed in President Bush’s 2001 tax package. However, the composition and rules of the Senate made permanent repeal all but impossible; Republicans could not gain the 60 votes necessary to avoid Byrd Rule challenges, which would have allowed any senator to stop the tax package. The only way around the Byrd Rule was to avoid any tax changes that extended beyond the budget reconciliation in question. The ten-year limit did that, but made the entire tax package sunset in the year 2011. The end result, then, was a death tax repeal that is fully implemented in 2010, only to be re-instated the following year.

The new tax package addresses many tax provisions, and may be included in another reconciliation bill, which means that the sunset remains a concern. The estate tax was not included because permanent repeal would be difficult in a reconciliation bill. So now Congress must pass a bill that specifically addresses the death tax. The House has already introduced legislation for permanent repeal. Not surprisingly, the Senate has yet to address the issue and it will prove challenging to finalize legislation for the president’s signature.

The Death Tax is perhaps one of the most difficult taxes to justify. Administrative and compliance costs of the tax are prohibitive, especially in relation to the small amount of revenue the tax generates for the federal government. In the year 2000, the tax generated roughly $30 billion, or about 2 percent of all federal revenues. However, the distortions the estate tax creates in the economy—disincentives to save and invest, the misallocation of capital—can cause a reduction in other revenues, such as the income tax, that offset the collections of the estate tax. Congress’ Joint Economic Committee (JEC) found in a 1998 study that, on net, the estate tax raised little or no money for the federal government.

In fact, the tax has created an entire industry of avoidance, distorting economic incentives and misallocating capital. The JEC study found that due to such distortions in the estate tax over the last century, the capital stock is lower by $497 billion. Another unfortunate side effect has been to place a real burden on small businesses and family farms that may not have the means to employ the accountants and lawyers necessary to minimize the sting of the death tax, which often means selling off land or selling the business to pay the taxes, which can reach as high as 55 percent.

Supporters of the death tax say there are no problems with the tax and that it is necessary to avoid the concentration of wealth at the upper end of the income scale. Yet these arguments are hard to match to reality. There tax does, indeed, create problems. Why else would a multimillion-dollar industry emerge to advise clients on the complexities of the death tax? Moreover, if there is no problem, why is repeal a top priority for small business and farmers? In actuality, the death tax is a problem, and small estates do fall under the gaze of the IRS; in 1996, 53 percent of death tax returns came from estates of $1 million or less, and 96 percent of the returns were from estates valued at less than $5 million.

Concerns about a repeal’s effect on the concentration of wealth are also unfounded. Income mobility in the United States is among the highest in the world, and economic opportunity is much more important issue than a tax code that tries to engineer income equality. In fact, economist Alan Blinder suggests the death tax can do little to address income inequalities and attributes only 2 percent of the income gap between rich and poor to inherited wealth. A vibrant marketplace that provides opportunities for all will have a far greater impact on economic well-being than a tax that the very wealthy can circumvent with a good lawyer and accountant.

For many reasons, the death tax should be eliminated. It is punitive, unfair, distortionary, and adds little to federal revenues. President Bush’s economic package includes important policies that will strengthen economic growth and address some of the inequities in the federal tax code. The death tax should not be overlooked in this process. The adverse economic effects of this tax far exceed any revenues it may generate. As the White House begins to focus on the country’s byzantine and costly tax code, it should not overlook the need to repeal the death tax permanently.