Should the Estate Tax Go? BECKER

The tax cut law of 2001 included a slow phase out of the estate tax by 2010, but the tax is supposed to be reinstated in 2011 when the entire 2001 law expires. This strange political compromise on estate taxes presumably will not last, so it is a good time to consider what should be done about this tax. I believe taxes on estates should be permanently abolished since they do little to reduce income or wealth inequality, benefit a vast army of lawyers and accountants whose role is to find ways to cut taxes on the estates of the wealthy, create problems for some families with smaller businesses, and do not raise a lot of tax revenue. In April the House of Representatives rather strongly voted to repeal permanently the tax on estates, so the issue now goes to the Senate, where some Democrats are promising a filibuster. In earlier times, bequests of assets, especially property, were the dominant way to pass economic wealth from parents to children. But after the knowledge revolution took off toward the end of the 19th century, bequests of financial and material wealth have become less important in the overall economy. Instead, the most important way for parents to “bequeath” economic position is through the transmission of knowledge in the form of education, training, and other human capital. Such capital embodied in people now comprises over 70 per cent of all “wealth” in economically advanced nations, far more important than material capital. In modern economies children of better educated, higher earning, and more able parents on the average receive greater training and schooling, better health, and are more encouraged to develop their talents than are children in other families. Primarily for these reasons, children of parents with greater human capital form an economic elite that tends to have better jobs, less unemployment, and higher earnings. But this elite circulates over generations, and there is no convincing evidence that the degree of circulation, the degree of social mobility across generations, has been falling during the last couple of decades. Some defenders of a sizeable estate tax rate claim not any major effect on inequality, but that it allegedly brings in lots of revenue with little disincentive to wealth accumulation and other behavior. However, estate and gift taxes in fiscal 2005 are expected to contribute only $24 billion in federal tax revenues, which is about 1 per cent of estimated total federal tax receipts, and just one third of federal revenue from excise taxes. The rise in exemptions may have reduced revenue from estate taxes, but this tax did not contribute much more even a decade ago. $24 billion is not small change, except to politicians, but if the estate tax were abolished, the lost revenue could be made up without difficulty with only modest increases in income or consumption taxes. A main reason for the small yield of estate taxes is that very rich persons with large estates often pay little to the government since they employ skilled lawyers and accountants to help them find ways to sharply cut their estate taxes. Trust and estate planning is the specialty of about 20,000 lawyers who, along with accountants, spend their expensive time discovering ways to reduce the amount owed in estate taxes. These ways include gifts, trusts that may skip a generation, insurance trusts, and charitable trusts and foundations. These talented individuals should be spending their time in more economically productive ways. Since the average estate-planning attorney earns more than $150,000, spending on 20,000 of them would be in excess of $3 billion. If another $1 billion goes to estate accountants, total spending on tax avoidance would seem to be in excess of $4 billion. This is more than 1/6th of the revenue generated by this tax, a strikingly high percent. The estate tax is a bad way to reduce the effect of inheritances on inequality in the distribution of incomes and wealth, even for families that do leave large estates. For this tax does not consider how many children, parents, other relatives, or friends share estate resources. A parent who leaves $10 million to an only child has a larger effect on the personal inequality of wealth in the next generation than does someone leaving the same amount to be divided among several children, nieces, nephews, friends, and employees. Similarly, a large bequest to successful children with high incomes raises inequality more than does the same size bequest to children with low or just average incomes. This is why taxing inheritances rather than bequests would be a better way to reduce inequality in succeeding generations. That is, $10 million in bequests divided five ways should generally be taxed at much lower rates than the same amount given to one person, while $10 million divided among several well off children should also be taxed at higher rates than the same amount divided among children with modest incomes. Although an inheritance tax would be better than the estate tax, I am not advocating a direct tax on inheritances, for there is a better approach that indirectly does tax inheritances (see the discussion later of consumption taxes). The estate tax also makes it harder for families to pass successful businesses on to their heirs. Despite the 2001 tax law that increased exemptions, families are still sometimes forced to sell more successful and profitable businesses upon death of the principal owner in order to pay estate duties. This is why farmers and other owners of small businesses continue to be active politically in advocating much lower estate taxes, if not their complete abolition. High tax rates on estates may be thought to be universal, but in fact many countries have low taxes on estates. Moreover, some countries, including Canada and Switzerland, essentially have not taxed bequests to close family members, although they may tax capital gains on assets transferred to children. I cannot go deeply in this discussion into the reasons why I believe a tax on consumption, perhaps a progressive one, instead of income and corporate taxes, should form the heart of the federal tax system. Suffice it to say that consumption taxes, unlike income taxes, do not distort savings decisions, a particularly important issue for the United States. A general reliance on consumption taxes would, among other things, replace an estate tax by indirect taxes on inheritances. The tax on inheritances would be indirect because they would not be taxed when they are received, but only as they are spent. So if a family receives a large inheritance that raises their consumption several fold, the amount they would pay in consumption taxes would also increase several fold for as long as the family continues to consume at a much higher level. So my conclusion is that the estate tax should go, or at least have greater reduced rates, since this tax has little effect on inequality in a knowledge economy, encourages costly avoidance behavior to take advantage of various tax loopholes, raises only a modest amount of government revenue, and reduces incentives to form family businesses and other entrepreneurial activity. Estate taxes do not even tax the right base if the aim is to reduce the effect of inheritances on inequality in the personal distribution of income and wealth. The energy and political capital spent on supporting high estate taxes is better spent on trying to raise opportunities to children from poor families by improving their education, training, and health.

Comments

[TheWinfieldEffect]

COREY: "Inheritance was considered an advance at a time when the crown was corrupt and tyrannical. Looking back to that time ignores the centuries of development in the realm of democratic checks on tyranny. If you are looking to check the government then you have a choice between the wealthy elites, or the polis. Problem is the wealthy elites are also capable of even greater tyrannies."

Like any majority, the poor are capable of tyranny.

[Joe Merchant]

"do you feel like there is any real popular control NOW"

You can fool 33% of the people all of the time.

You can fool 51% of the people some of the time.

Following the above, elected leadership can pull off heinous acts aggregious to the entire populace some of the time, and still get re-elected.

But, if the elected leadership starts grinding down more than 83% of the populace on a continuous basis, they should be thrown out under the current system.

Scary what a few fools will allow to go on.

Sadly, I think that whatever is done about the estate tax will be such a small matter in the minds of the voters that it will be a non-issue in upcoming elections.

[TheWinfieldEffect]

[[["After all, people who only make $25k aren't starving."

Depending on where they reside they aren't really living either. Have you ever gotten by on less than $35K a year since leaving school?]]]

Some people in some countries sell their kidneys to provide for their families and they have never been to school. They cannot read. They die from measles and polio. No one making $35k per year in the United States of America is "not really living".

[Joe Merchant]

""And no, we do not need more Paris Hiltons."

Spoken like a man who hasn't visited Paris and been inside the Hilton."

I did not notice the building being particularly crowded when I stayed there. Good food, mediocre service, dreary architecture.

And, the benefits to society of a recognizable brand medium luxury hotel conveniently located in high traffic locations do not, I think, outweigh the degredation of values perpetrated on society by the hotel mogul's offspring.

If you haven't seen the South Park "Paris Hilton" episode, you should. I believe it is readily available via bitTorrent....

[TheWinfieldEffect]

THE ESTATE TAX

The estate tax is favored by cynical politicians who know that heirs of multimillion dollar estates are outnumbered by non-heirs. Thus, more voters benefit from the estate tax than lose out.

These cynical politicians are usually populists, and so are on the Left. Their campaign and fundraising rhetoric slurs heirs as greedy and undeserving. After all, heirs didn't earn their inheritance. The little guy loses out if the greedy rich are able to spend their dollars how they choose.

CYNICISM: BRINGING DEMOCRATS TOGETHER

The Left benefits politically by restricting the use of capital by rich private persons, natural or state-created. First, corporations and rich individuals have less money to spend on elections and lobbying for free market policies. Second, the extremist rhetoric keeps Leftist politicians well-financed and in office, because extremist rhetoric energizes the far Left, which maximizes the number of small "hard money" donations incoming to tax-exempt liberal groups and the coffers of liberal loudmouths like Chuck Schumer.

HOW TO HELP THE POOR, WITHOUT HYPOCRISY

The way to improve the lot of poor people is to grow the economy. Don't take my word for it, take the word of Professor Bhagwati of Columbia University, who used that very strategy while an economist on the Indian Planning Commission to raise the minimum income of India's poor (defined as the bottom 30% of India's wage-earners). He is quite explicit in "In Defense of Globalization" that:

"[G]rowth was not a passive, trickle-down strategy for helping the poor. It was an active, pull-up strategy instead." p.54
...
"[G]rowth had to the principal (but, as I argue below, not the only) strategy for raising the incomes, and hence consumption and living standards of, the poor." p.54
...
"A suitable growth policy can always nip the immiserating growth paradox in the bud, ensuring that growth does amount to an increase in the size of the pie." p.55
...
"We must also improve the poor's access to investment by making sure that bureaucrats are replaced by markets wherever possible. As I remarked earlier, the anti-market protesters do not adequately appreciate that, as has been documented by numerous development economists who have studied both the working of controls and the rise of corruption in developing countries, far too many bureaucrats impose senseless restrictions just to collect bribes or exercise power. Letting markets function is therefore often an egalitarian allocation mechanism." p.58

I ask you this, my friends. Does the estate tax "let the market function"? If not, why is Corey opposed to an egalitarian allocation mechanism? Isn't he supposed to be an egalitarian? Or is he just an elitist in populist clothing?

[TheOC]

R,

I disagree. The particular method that I used to obtain my wealth might have involved luck, but the fact that I obtained it had more to do with hard work and determination. I guess you could argue that inheriting intelligence is lucky, but there are plenty of smart people who are not wealthy.

There is very little difference between taxation and theft. Either way, someone takes your stuff by force. At least you can argue that income tax pays for the police protection they receive. But a dead person does not get anything from the government. Seventy percent to transfer value? I would rather take my chances with your angry hordes.

And I am not fond of either major party, but I am closer to a Democrat than a Republican.

[Corey]

Winfield, you are really going to rely on the old "eat your peas because there are starving children in _____" argument? OK, then is it relevant that many of those desperate people in other countries that you refer to have jobs making shoes and cutting down bananas that end up being consumed in America? (yet they still can't manage to get by) Because I think its the same debate, on a global scale. Plus then we get to talk about why the US is willing to offshore business but won't export the rule of law. Seems like we've covered that ground though.

Is it relevant that Americans have attempted to sell their kidneys on EBay?

You can call me a bitter worker if you want, there are more of me out there. I have a right to be bitter, I was shafted and left with nothing in exchange for years of hard work. For a while I was paid more than I was worth, fortunes rise and fall. I am unique only in the sense that I have stopped trying to win that way, and am pursuing other options in the higher education system.

I think I have presented a critique that is worth more than a "you are bitter" dismissal, but its your perogative.

[Joe Merchant]

"No one making $35k per year in the United States of America is "not really living".

It depends upon how it is done. In graduate school (in the US), I made $14K per year and toured Europe two summers in a row, paying all my own bills, including rent on the (small) apartment I wasn't using stateside during the summers.

No, I did not stay at any Hiltons during those trips.

Upon graduation, I made $36K per year, and I was a wage slave. I bought a home in the ghetto (best investment of my life, as the ghetto retreated and values tripled in 10 years), and didn't have enough free time to do anything substantial in my life.

My quality of life was better earning $14K per year, working about 800 hours.

At $36K per year working 2000 hours, I was able to buy a new car and a invest in a small house, contributing more to society, I suppose, but net enjoyment of life was seriously diminished.

In today's America, there are precious few choices of employment that will pay a reliable $50 per hour, while allowing more than a few weeks per year of vacation. Unless you happen to inherit a moderately sized fortune which you can effectively invest and manage for about 100 hours a year.

[TheWinfieldEffect]

BECKER: "Suffice it to say that consumption taxes, unlike income taxes, do not distort savings decisions, a particularly important issue for the United States."

In other words, you're only taxed when you spend. If you don't spend, you get to accrue compounding interest and keep it or pass it on. It means instead of borrowing, poor people can simply spend less. This will get rid of a lot of junk economic behavior, as poor people opt not to spend money on frivolities. The only problem is that there is a limit to how much poor people can cut their costs (a reason for progressivity), and the progressive consumption tax would need to be administered a cost which would fall on the seller of the goods being consumed, which means an across-the-board increase in sticker prices, which affects buyers with lower savings disproportionately. (Unless Becker is in favor of socialist price controls, which we all know would lead to rationing....)

[TheWinfieldEffect]

Plus then we get to talk about why the US is willing to offshore business but won't export the rule of law.

I don't think "the US is willing to offshore" any business. Multinationals that are thought of as American corporations are offshoring. But that is not a government action. I think the inability of you to make that distinction is telling. George W. Bush has not implemented a executive order commanding multinationals headquartered here to offshore. But I am sure you will make up some conspiracy theory to the contrary, probably involving your stolen patents.

[TheWinfieldEffect]

"No, I did not stay at any Hiltons during those trips."

I was clearly making a vulgar sexual Paris Hilton joke. Perhaps your lack of humor is proof that you are "not really living." I'd advise you to abscond to Bangladesh immediately, where workers have it much better, according to Corey. But don't go to Hong Kong or Singapore, former British colonies with an Anglo-style legal system and governance, including property rights, because they, apparently, don't have rule of law. Evil empires never export rule of law. Especially not in Iraq, which is writing its Constitution, or Afghanistan, which already wrote its. And never mind that Kuwait, which we freed from Iraqi occupation in 1991, just gave women full political rights. No, no, America is evil because it "offshores patents".

[TheWinfieldEffect]

"Is it relevant that Americans have attempted to sell their kidneys on EBay?"

No, because Americans don't sell their kidneys to put food on the table. I'm sure that person was a get-rich-quick libertarian who'd just read a book by Richard Epstein.

[TheWinfieldEffect]

"OK, then is it relevant that many of those desperate people in other countries that you refer to have jobs making shoes and cutting down bananas that end up being consumed in America?"

It means cheaper goods for poor American workers, which means increased purchasing power for poor American consumers (who are also workers), which means more money potentially going into savings for poor people. You want poor Americans to have an increased chance of accumulating wealth, don't you, Corey? Or would you prefer that poor Americans not be able to buy cheap goods they like at Wal-Mart and Target? You like higher sticker prices for poor Americans, is that it? Because higher sticker prices in American stores are in essence a tax on poor Americans. You think poor hard-working Americans should pay more taxes because of your liberal sympathies for distant foreigners? It didn't realize that "egalitarian" was spelled E-L-I-T-I-S-T.

[Corey]

I don't think of them as foreigners Winfield, I think of them as people like me. Aparently, they made my shirt and I am looking for a way to say thanks.

If you want to put words into my mouth, invent things I never said or implied (re: Bangladesh), and turn me into a talisman for your latest crackpot redefinition of terms... then have at it. I believe in the things I say with all of my heart. That may not be enough for you but it is enough for me.

[TheWinfieldEffect]

"I don't think of them as foreigners Winfield, I think of them as people like me. Aparently, they made my shirt and I am looking for a way to say thanks."

Then why don't you adopt a Bangladeshi. Your personal and private belief in cosmopolitanism is no reason to support raising taxes on the working poor in this country, which is a public act that affects millions of households. If you don't think an increase in sticker prices is a tax on the poor, maybe you consult some recent Democratic speeches opposing the idea of switching to a consumption tax. (or an economics or tax law textbook.)

[Not Corey]

Corey writes: "I think I have presented a critique that is worth more than a 'you are bitter' dismissal, but its your perogative."

Nope.

Do you have hammer and sickle sheets on your bed?

Brain dead.

[Mike Petrik]

Joe Merchant,

Responses to your comments enumerated above;

1. The historic $600,000 exemption was per donor, not per donee.

2. A progressive federal consumtion tax can be easily achieved by expanding IRAs through removing the $3600 annual cap and allowing taxable distributions at any time. In essence, this would exempt net current savings from the tax base leaving consumption to be taxed on a graduated basis. William Andrews of Harvard suggested a variant of this thirty years ago and Sam Nunn offered it as legislation last decade. In my opinion inter vivos as well as testamentary gifts (as distinguished from charitable contributions) should not be deducted from the base. Alternatively, a sales tax style tax could be made progressive by exempting basic needs such as food, medicine and shelter. You are correct that such exemptions would introduce the potential for gamesmanship and complexity, but it is not clear that it would be any worse than our present system. However, this alternative would be especially susceptable to the "additional tax" risk that you mention.

3. Huge estates diminish over time without the help of the government. Just look at how little is left of the original Rockefeller and Kennedy estates, and through good planning they have paid little in estate tax. Of course, some of that planning has been accomplished by the use of private foundations. The mischief those foundations have caused is staggering.

[Jerry]

I am not sure that Becker is correct in observing that the estate tax is inefficient because of the number of lawyers and accountants employed to avoid it. Although I havent' seen any research on the point (and there must be some) my personal observation is that there are many expensive lawyers and accountants employed at the upper margins of any tax system. Are more lawyers and accountants employed per dollar collected from taxpayers with large lifetime plus death transfers than from individual and corporate income tax payers paying over 30% marginal rates on ten million dollars of income? I doubt it. The difference is that the federal income tax collects much of its revenue by withholding from lower- and middle-income tax payers who cannot save much by hiring lawyers. At the upper margins of income taxation, lawyering is probably more prevalent than at the upper margins of estate taxation.

[R]

winfield -- the argument isn't that theivery is moral, but that taxation is moral. We have no absolute right to private ownership that can be abrogated by the government. Because ownership itself relies on government protection, and for other reasons that are mentioned above. It isn't my argument, though I'd like to lay claim to it.

I have been to Paris; its lovely, have been inside neither the Hilton, Paris, nor Paris Hilton, though they each service multitudes.

[R]

"The particular method that I used to obtain my wealth might have involved luck, but the fact that I obtained it had more to do with hard work and determination."

How can anyone be sure of this? Conceding that markets are unpredictable -- that luck plays some role in your wealth accumulation -- are you not a little cautious about quantifying the amount of luck responsible, versus the high estimate of merit you bestow upon yourself?

One difference between theft and taxes, that seems quite obvious, is that the government can lay a valid claim upon you wealth. Your money -- and your ability to protect it -- is a construct of government action.

[R]

"Because higher sticker prices in American stores are in essence a tax on poor Americans."

This is a ridiculous statement. If you want to call any increase in cost a "tax" -- well that's pretty tortured, in that the traditional definition of tax is a cost directed to the government, and not just anywhere -- but fine, do so. But the "tax" you describe is no more a tax on poor people than a tax on everyone. Sure, higher prices are bad, and poor people, because they are poor, might feel the pinch a bit more, but that doesn't make it solely a tax on poor people -- in as much as it can be called a tax at all, which it isn't.

[monkyboy]

Currently, the wealthies 1% of Americans have an income of about 80 times the average family in the lowest quintile.

Perhaps that number could be the estate tax rate...80%

Might give the Masters of the Universe an incentive to raise their workers pay. How hard would it be to get that number around 50?

[TheOC]

"How can anyone be sure of this? Conceding that markets are unpredictable -- that luck plays some role in your wealth accumulation -- are you not a little cautious about quantifying the amount of luck responsible, versus the high estimate of merit you bestow upon yourself?"

There are all kinds of factors that affect someone's potential for wealth accumulation. High School grads make more than drop outs. College Grads make more than HS grads. People who do not have children as teenagers are wealthier than those who do. Those who live frugally save more than those who live beyond their means. None of these are random events.

You are right that I cannot entirely discount the role of chance, but there are things people can do to put themselves in a position to be in the right place at the right time.

"One difference between theft and taxes, that seems quite obvious, is that the government can lay a valid claim upon you wealth. Your money -- and your ability to protect it -- is a construct of government action."

If I were able to avoid paying taxes in exchange for waiving any government protection of my assets, I would gladly do it. But they do not offer that option.

[TheOC]

monkyboy,

You are falling into the trap of zero sum thinking. Rather than worry about the top one percent versus the bottom twenty, look at the state of the bottom twenty percent. The places where "poor" people are doing the best are the places that have the largest disparity between rich and poor.

Previous attempts to reduce the ratio between rich and poor have succeeded by reducing the wealth of both classes.

[monkyboy]

Hehe, TheOC, we've had 25 years of "trickle-down" economic policy and the lowest quintile in America has the exact income they had when Reagan took office.

If you look closely at most fiscal policies, they are designed specifically to help the richest 1% of Americans. The question is, why can the Republicans fool so many poor people into thinking they actually want to help?