There has been discussion recently that President Trump will soon be providing a tax reduction proposal to Congress to help stimulate the US economy. One aspect in the proposal will likely be a repeal of the estate tax, often referred to as the “death tax”. I think it is important to look at why this tax is often debated and whether it will be a part of the final tax proposal that will be voted on by Congress.
The estate tax was started just over 100 years ago to help fund the costs of WWI. It has remained in the tax system ever since, except in 2010 when it was removed for only one year and reinstated in 2011. It is a tax on someone’s property and assets at the time of death before the property is given or transferred to another person or entity.
Opponents of the estate tax have been able to convince many Americans that it is a “death tax,” which makes it seem somehow morally wrong. Surveys have shown that most Americans seem to agree that it seems un-American and against the basic principles of capitalism to tax a dead person. However, those same surveys also show that only about 3% of the public think the law should be viewed as a priority to fix or repeal. This is probably because the tax affects so few Americans. As currently written, the estate tax has large exemptions ($5.49 million for individuals and almost $11 million for couples) and it affects very few people when they die. The facts show that only 2 out of every 1000 estates owe ANY money due to this tax. Opponents of the tax stress that the US estate tax rate of 40% is among the highest in the world, while the world average is around 15% and the medium is 7%. Proponents of the tax state this is misleading because with the exemption amounts the actual real rate is approximately 17%. Opponents of the tax, like economist Milton Friedman and Gregory Mankiw, believe the tax violates the concepts of fairness and creates an environment where wealthy families spend time, money, and resources trying to avoid the tax and it hurts the long run productivity and economic growth of the economy.
The key points on the debate often center around the topics of double taxation, revenue for the Government, economic equality, and the emotional components that follow from these issues. Opponents of the tax often state that these estates are being double taxed; once when the person earned the money and then again upon death. This seems unfair and wrong. The proponents of the tax feel this is a misleading statement. They demonstrate with facts and data that almost 55% of the wealth created in many of these estates has been accumulated with capital appreciation that up till death has never been taxed. The laws allow a step up in tax basis upon death, so if the estate tax did not exist these capital gains will never occur nor be taxed by the Government.
The estate tax generates approximately $19 billion a year in revenue which is only 0.6% of the Government receipts. Opponents feel this relatively small percentage could easily be replaced by cost cuts in other Government programs or even more likely, the revenue would become even more than before because the repeal of the tax would stimulate economic growth and improve productivity. Those backing the tax strongly disagree, especially in our current environment of budget deficits. Studies show that repeal of the tax would cost over $250 billion in lost revenue from 2016 to 2025. As a result, this shortfall would need to be funded with additional debt and the interest that goes with it bringing the actual costs in excess of $320 billion. They believe that this shortfall would only hurt the poor if Government programs were cut, or it could hurt all Americans if we create a new tax on the middle class to make up for this tax benefit to the wealthy in this country.
Opponents of the tax often use emotional examples of how the tax hurts everyday Americans to make it feel like an unfair tax. The classic example most widely used is the farmer and small business owner. The fear is that the farmer’s family can’t pay the estate tax so the children end up selling the farm. Individuals, such as Chloe Cho at the Center on Budget & Policy Priorities, have shown that this is a very misleading example and is a myth. They demonstrate that of the roughly 5200 estates that file an estate tax each year, only 50 or roughly 1% of them are small businesses or farmers. This is equal to .002 percent of all estates in the country- not enough to use as the reason the tax is unfair enough to be eliminated.
Finally, income equality is often discussed in this debate. Opponents of the tax believe it does not seem right to punish a person for saving over the years. They fear it creates negative incentives to not work hard if much of your wealth is taken upon your death. They also fear that personal savings will be lower if each person feels it will not benefit their families upon their death. Proponents of the tax disagree. They feel the tax helps prevent massive wealth accumulation in the hands of a select few families and may even improve overall productivity by forcing children of wealthy families to have an incentive to work hard and not be dependent on an inheritance to help them. Equally, they feel the wealthy have an obligation to help others less fortunate. They argue the estate tax allows the Government to use some of this wealth through Government revenue or savings to pay for Government programs that help all people in the economy. Additionally, it is their belief that the estate tax is our country’s most progressive tax and should be maintained.
The debate over the estate tax will most likely commence in the coming months. Based on the facts and the political climate we are currently facing in Congress today, it will be a heated debate. The topics of income inequality, creating benefits that seem to favor the super wealthy, and creating an even larger Government deficit do not seem to be topics that many politicians want to deal with in today’s environment. More than likely, the 60 votes necessary to pass a tax reform bill in the Senate will not include a repeal of the estate tax. In the end, this 100-year-old tax will probably remain in the tax law and President Trump, like so many politicians before him, will not accomplish what he said he would do while campaigning for President.