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

[Daniel Chapman]

R - "ridiculous" is a little harsh. The idea has merit even if the word "tax" isn't a perfect fit. If congress decided to set a policy of no trade with China, there would be costs. These costs would be paid through higher prices on cheap consumer goods that aren't usually purchased by the upper class.

I think you see this, though.

[text]

OC -- I don't think you fully grasp my point. It isn't just police protection that you would have to forgo, but the entire infrastructure set in place by the government to create private markets. An important one would be the mint. Then we also have the SEC, the federal reserve, etc. It isn't just that you require a government to protect your wealth (you do) but that the existence of private wealth in non-cattle form is predicated upon a government. Without a government, you could presumably acquire a flock of sheep, and trade for goods and services. But a more liquid form of wealth requires a government. Otherwise it does not exist.

This is why arguments that begin "taxes are immoral" are so very unappealing. It seems obvious that they aren't, and it makes one question whether the speaker genuinely believes what he is saying.

[R]

Daniel --

I see your point, but it isn't only use of the word "tax" that bothered me, but the unsupported assertion that the "tax" was exclusively "on the poor."

There is actually evidence that the very rich and very poor alike buy basic consumer goods on the cheap. We need to define more readily what kinds of goods we are talking about before the statement can be proven true. For instance, evidence suggests that the rich don't buy name brand cereal. There isn't much evidence that rich people shy away from bargains.

There are other examples -- such as state lotteries -- which actually do act as taxes upon the poor. State lotteries are both (1) taxes -- in that the money goes to the government -- and (2) primarily targeted to the poor -- because poor people buy more lottery tickets. I don't think (1) or (2) necessarily applies to the example. It was so hastily thrown out there that I think it deserves whatever I called it.

[Bernard Yomtov]

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.

And what will you do when someone at the bank or brokerage house transfers your account to his name, or when a gang of thugs moves into your house while you are at work, or someone decides to tow off your car?

Maybe you're willing to take a chance on your house burning down, but who do you think will sell you insurance if they know the fire department's not going to show up?

[Daniel Chapman]

Fair enough, R.

[RWS]

monkeyboy (and others on the liberal side):
Check out "Report Exaggerates Income Equality," by Robert Rector and Rea Hederman, L.A. Times, Oct. 7, 1999, at B11. This article goes into detail as to why the lowest quintile is not nearly so bad off as many spin it, and why people tend to misread the data on inequality.

Second, check out "Still the Land of Opportunity" by Pete Du Pont, Tampa Tribute, May 4, 1996, at NATION/WORLD p. 15. This article details the extraordinary economic mobility that exists in the United States.

Both are available on Lexis or Westlaw, and probably DowJones. I would challenge anyone to refute these analyses of the data.

[monkyboy]

It sucks to be in the lower quintiles in America. The need for many social programs derives from this fact, RWS.

Whether your stay in the lower quintiles of American family income for 10 years or 50 years is beside the point.

"You shoulda gone to Harvard and held off on having kids," sounds an awful lot like, "Let them eat cake!"

[RWS]

I assume you do not dispute the basic factual accuracy of the above analyses.

I wouldn't say "you should have gone to Harvard," of course. Your statement is a parody of my point. Going to a community college, on the other hand, is hardly out of the question. One with only a GED can go to our local community college for a health services career and come out with a very nice salary and stable job with benefits. I do not believe this assertion is Marie Antoinette-ish.

I would say that holding off on having children would be a good thing for many, especially the unwed and those who have not yet established themselves. I would not quarrel with that.

[Aside: Enjoyed the comments of Professor Becker on the "Chicago boys" in Chile this morning on NPR.]

[Raakaa]

I wouldn't say "you should have gone to Harvard," of course. Your statement is a parody of my point. Going to a community college, on the other hand, is hardly out of the question

[Corey]

"Check out "Report Exaggerates Income Equality," by Robert Rector and Rea Hederman, L.A. Times"

So a couple of Heritage Foundation arch-conservatives manipulate census data at the 1999 peak of economic growth and we are supposed to forget that we passed 5 homeless people last time we walked down the street?

Who here has ever been in the lower quintile? Anyone? Who here is in it now? Anyone? Lets look for some news stories to tell us that its not so bad then. Don't we feel better knowing the poor are doing just peachy and they love their prospects.

[monkyboy]

I'm hardly a liberal, RWS. Just pointing out some numbers. Look at income distribution, not in percentages, but in actual dollars. Two sets of American families, roughly the same size.

$ 325,440,000,000 is split between one group
$4,010,520,000,000 is divided between the other

That is the difference between the top 5th of American families and the bottom 5th. But few in the top 5th are asked to pay estate tax. That falls mainly on the top 1%. Dr. Becker points out this tax brings in about $25,000,000,000/year.

The income for this group is over $1,000,000,000,000. I think they can afford it.

[Joe Merchant]

Mike P -

Thanks for your responses.

Yes, my tax law is a little weak - and I do not feel particularly compelled to learn today's inheritance tax law details, as they will undoubtedly change before they affect me directly - even if that is next year.

I have, however, "Lived in a brownstone, lived in a ghetto, I've lived all over this town." (Talking Heads)

Nobody likes to pay tax.

The rich have the power to have exceptions made for themselves, whether they are massive landholders (farmers), corporate tycoons, or .com lucky kids.

Uncapping the IRA is an interesting form of consumption tax, I could almost get behind that, but it will be hard to phase in during deficit spending (gee, when was the last time we didn't have deficit spending, oh, I digress...) due to the loss of revenue for 20-30 years while worker bees horde their income. Exceptions for food, medical care, etc. are less attractive to me - due to the petty bickering that will flare up along the boundaries - are cigarettes groceries? No, well, how about the double chocolate fudge ice cream that is now being peddled by the tobacco companies, yes? Well, what about nutraceutical performance enhancing beverages at $5 a pop? Same thing happens in health care for things like breast implants, cosmetic tattoos, etc. Better to have a system that is inherently arguement free, unless you are a lawyer; and there aren't any lawyers elected to federal office drafting our laws, are there?

And, then, if anybody outside the bottom two quintiles cares, there are those folks who think that IRA is some Jewish banker who wants them to deposit their money with him - where they won't have access to it for things like food, rent, clothes for the kids, etc. And, in a sense, they're not far off the mark. Uncapping the IRA won't make a hill of beans difference to a lot of people. In fact, if these folks wanted to save in an IRA, it's practically uncapped for them today.

Until my company put up matching funds for their 401(k), I never had a tax exempt retirement account - instead, I got lucky and leveraged myself heavily into real-estate around the turn of the millenium. Any IRA that I could have accumulated with my real-estate investment principle would look pretty sad compared to what I have now, especially considering the negative return many mutual funds had during the same timeframe.

At least we have enough transparency in our system that we can see the rich padding their own pockets, hopefully that will remain in place and serve as some deterrent to falling down the rabbit hole of >99% in the hands of

[Joe Merchant]

Oh, and everyone loves to bash the yacht tax... anyone who didn't see that result coming wasn't thinking more than 1/2 step ahead.

Of course there are other countries in the world where you can buy a yacht - in fact, many of the big brokers in the US specialize in bringing in these massive luxury craft from overseas.

If you pass a tax on cigarettes sold from stores on the north side of the street, you might expect more cigs to be sold on the south side (there is a grocery store in my neighborhood that faces 90 degrees to the main street to circumvent a liquor restriction law.)

I think the yacht tax might have been pushed through by a few schemeing plutocrats just so they have an arguement to throw at the towel boys for the next 50 years.

Nah, plutocrats aren't really that clever.

[monkyboy]

Joe, I think we'll have to wait a few years to see who was clever.

Even if the poorest 60% of Americans were taxed at 100%, the revenue wouldn't equal the federal budget. The budget keeps getting bigger, the plutocrats keep getting their taxes cut, and the debt keeps growing.

I can't tell what's going to happen, but I suspect the poor will just eat the rich in the end.

[Alban Browaeys]

From Europa, regarding our histories and the news i can grab your are already a fascist state (not like nazi but like napoleonian days).

And:
"You can fool 33% of the people all of the time.

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

is true ... except if you use war or terror . We hadgreat examples in Franceof those with Robespierre and Napoleon.

And a fair consomption tax is a myth. When we already have a hard time getting fair data about what is owned ...
How would a state find out one bought his yoat in korea ? I bought this book on ebay from a russian student ... or that my dad paid a relaionship to help him build this wall. And so on .

Economics is the science of HUMAN economy. Not some sort of robots who do everything in a predictive ways.

And you are paid to find out how to best rules a world that does not exists . That s tell a lot about your axiom about the relationship binding wealth to effectivness.

Though you are right you are really smart. Finding out how to earn your living while doing useless research is really clever. I bet you have to work really hard to keep everyone from finding out.

Thankfuylly a lot of dumbass prefer keeping working really hard to keep the social consistency to our nations and avoid civil wars as in the nineteenth century than fighting such social abuses.
I hope it will last as i prefer a mad world for my family than civil war ... it helps for them not dying.

But at least have the decency to avoid telling bullshits and tell that they are lazy. It is the least you can do to reward them behing dumb (or smart enough) to understand why they do not turn violent.

[Alban Browaeys]

I don't understand how you go from "the estate tax" is inefficient as in our information age most of the wealth is given through education to "we should tax consumption".

The obvious conclusion is to tax education for wealthy families and education credits for the poor ...
Isn't that obvious ?

[chinna]

in developed countries how much percentage of inheretance tax is paying please give details about inheritance tax in developed counties

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