Die Death Tax, Die

Investors do not like uncertainty. If, as Ralph Waldo Emerson said, “The wheels and springs of man are all set to the hypothesis of the permanence of nature,” it is the belief in the permanence of law that sets all commercial activity in motion. Deprive investors, merchants, and consumers of legal certainty and they will retrench. Consumption will fall, discretionary risk capital will dodge risks, and all commercial exchange will slow as parties on both sides of the trade look for ways to hedge their bets.

A quick survey of developing economies underscores the role of legal stability in attracting investment. Nations that defend the integrity of their currency, enforce contracts, and respect property rights have little trouble attracting foreign capital, all things being equal. Conversely, the economies of countries that inflate their currencies, expropriate land and factories, and insulate domestic constituencies tend to founder. Attractive tax and regulatory regimes are also of little value if regarded as transitory.

For all of its merit, the tax cut signed into law by President Bush last June suffers from this important problem. Lacking the 60 votes in the senate necessary to make the tax cut a permanent feature of law, the president was forced to settle for a 10-year tax cut due to expire in 2011. While the economic and budgetary effects of changes in tax policy are always difficult to predict, there is little doubt that the economic effects of the favorable changes to the tax treatment of savings, investment, and work have been muted by the law’s impending sunset.

None of the tax cut’s provisions have suffered more from this uncertainty that the death tax repeal. Before passage, the federal government confiscated 55 percent of every estate in excess of $1 million at time of death. The Bush tax cut will raise the applicable exclusion amount to $3.5 million over the next 8 years, and reduce the tax rate to 35 percent over the same period before the tax is completely repealed in 2010. But in 2011 the death tax reverts back to the same $1 million exclusion and 55 percent rate.

Thus, last year’s death tax repeal has little or no economic value because it does nothing to change incentives, or behavior. Unless the estate owner knows that he will die in 2010, he will still devote the same resources towards tax avoidance, instead of productive use. For all of the death tax horror stories – it is estimated that 70 percent of all small businesses and farms never make it past the first generation, while 87 percent do not make it past the second generation, largely due to the death tax – the main case for repeal rests on the dead weight costs of the tax.

A study released last April by The Associated Equipment Distributors estimated that America’s family-owned businesses have spent $22.9 billion on estate planning services and $132.85 billion on estate tax-related insurance premiums to date. In annual terms, insurance premiums to provide immediate liquidity for survivors to pay the death tax amount to over 50 percent of annual death tax revenue. And companies with less than 20 employees paid two and a half times as much of these premiums – 43 percent of the total – as companies with over 100 employees.

Beyond costs associated with estate planning and insurance, the death tax also encourages affected taxpayers to purchase consumables – usually for their own enjoyment – instead of durable, capital goods, or securities for their farms or businesses. Senior business owners are also less motivated to grow their company, since the family recoups less than half of any additional value. And the gift tax – which remains at 55 percent even in 2010 – makes it unwise to pass ownership to a son or daughter prior to death.

While it was nice of Congress to repeal the death tax last year, it was a desultory change in law that has virtually no positive economic effect. Thankfully, Senator Jon Kyl (R- Ariz.) is pushing permanent Death tax repeal as an amendment to pending legislation in the Senate. Senate Majority Leader Tom Daschle (D-S.D.) is doing his part to keep Kyl’s amendment off of the floor, but many political analysts suggest that Kyl may have the 60 votes necessary to bring it to the floor.

If it comes to a vote, this much is certain: Foes of the taxpayer will brandish charts that show that the tax will benefit a small percentage of the richest Americans, while pretending as though the death tax revenue is solely responsible for financing whatever government program is most favored at the time.

But can a tax that is estimated to cost twice as much in compliance as it collects for the Treasury really be justified? Should tax policy be ignorant to the ways taxpayers invest in a parasitic class of lawyers and accountants instead of plant, jobs, and equipment to circumvent tax laws? Should $14 billion be sucked from the economy each year just to pay for insurance policies so survivors can pay taxes? These are the real questions raised by the death tax, and the Senate should address them by repealing this outmoded tax.