Reasons to keep the 'death tax' alive

Author: Paul Taylor

Published: August 14, 2003

Estate taxes, first levied in the US in 1916 to help finance the first world war, have been controversial from the outset.

Almost everyone agrees that the old system of estate duties and gift tax is flawed and needs to be reformed. But the more important question today is whether estate and gift taxes should be modified or abolished entirely.

I agree with William Gale, of the Brookings Institution, a think-tank, who argued in a recent paper that sensible reform would bolster the strengths of the estate tax and avoid the pitfalls implicit in abolition.

The debate over estate tax has been given new impetus by recent reforms that steadily phase out the tax by raising exemption levels from Dollars 600,000 in 2001 to Dollars 3.5m in 2009 while reducing the top rate from 55 per cent to 45 per cent.

Under the latest tax changes pushed through by the Bush administration, the estate tax disappears altogether in 2010 before a "sunset" provision kicks in and restores the pre-2001 tax exemptions and rates the following year.

The debate divides some of the nation's richest families. For example, while the heirs to some family fortunes have lobbied hard against a tax code provision they have dubbed "the death tax", many others have signed a petition framed by Responsible Wealth (an organisation co-founded by Chuck Collins) that supports reform but not eliminating the tax.

Other active campaigners for reform rather than abolition include Bill Gates Sr, father of the co-founder of Microsoft and chairman of the largest private philanthropic foundation in the world.

There are many good arguments for keeping the estate tax in some form - not least the fact that it is by far the most progressive source of federal revenue. As Mr Gale notes, despite the perception that advocates of repeal have created, the vast majority of estates are not subject to the estate tax.

Only 2 per cent of deaths result in any estate payments at all and about half of all estate taxes are paid by the wealthiest one out of every 1,000 estates. Repeal would be a massive giveaway to the nation's wealthiest dynasties.

The estate tax also helps close what otherwise would be gaping loopholes in the income tax with respect to capital gains and other items. Repeal would foster sheltering schemes that would drain massive amounts of income tax revenue from federal coffers at a time when the federal budget deficit is growing.

The tax also helps support the non-profit sector by providing incentives to give to charities at precisely the time when people are distributing large amounts of wealth. Mr Gale's own research indicates that repeal would reduce charitable giving at death and during life by about Dollars 10bn per year. This represents 5 per cent of all charitable giving and is equivalent to the annual grant-making of the nation's 100 largest foundations.

Opponents point out that, compared with other taxes, estate taxes raise very little revenue. That is certainly true now but before they were slashed in 2001, estate taxes were slated to raise about Dollars 400bn over the next decade. Put another way: retaining the estate tax, rather than repealing it, would pay for half of the entire Social Security shortfall over the next 75 years.

Despite claims that estate taxes pose a threat to small family businesses and farms, the reality is different. The majority of small businesses are too small to face the estate tax and there are already provisions that allow family-owned businesses and farms to shelter two to three times as much as others taxpayers can, and these could be expanded.

By labelling the estate tax as the "death tax", abolitionists clearly hope to win popular support. But about 98 per cent of people who die actually receive a "death subsidy" because taxes on accumulated capital gains are forgiven and they do not pay estate taxes.

Even where estate taxes are due, they do not need to be paid at the time of death. They can be pre-paid with prudent estate planning devices such as life insurance and, for small businesses and farms, the payments can be stretched out over many years.

All taxes impose burdens and the estate tax is no exception. But the larger question is whether the burden per dollar raised from a tax on someone who inherits millions of dollars is more or less than the burden imposed on society if the estate tax is eliminated.

Surely a tax that is progressive, closes loopholes, provides equality of opportunity and encourages charitable giving cannot be all bad. Of course, it could be reformed to emphasise its benefits and minimise its costs.

This could be done by closing loopholes, reducing rates modestly, indexing the tax for inflation and letting the exemption rise as scheduled. This would focus the tax on the truly wealthy and at the same time make it simpler and fairer.