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Back from the Grave
Revenue and Distributional Effects of Reforming the Federal Estate Tax
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In this paper we review the current wealth transfer tax rules and the changes introduced in 2001. We offer an overview of the methodology underlying the TPC's estate tax model and then use the model to estimate the number of estate tax filers, taxable returns, and the distribution of burden under current law. Finally, we investigate the revenue and distributional effects of several proposals to reform the estate tax, including those put forth by the presidential candidates.
The estate tax is the most progressive component of the federal tax code. In 2000, even before substantial cuts were enacted, it only applied to the wealthiest two percent of decedents. Advocates argue that the tax is also an important backstop to a loophole-ridden income tax and that it encourages charitable contributions. Critics have attacked the levy, which they call the “death tax,” as complex, unfair, and a deterrent to saving and investment. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate tax has been phasing out and will disappear entirely in 2010 before rising from the dead the following year in its pre- EGTRRA form. Congress has resisted repeated attempts to repeal the estate tax permanently, but the specter of a gruesome one year “death tax holiday” in 2010 guarantees that Congress will act before then.
Both 2008 presidential candidates would scale back—but not eliminate—the estate tax which, under current law, will generate about $490 billion through 2018. Senator McCain proposes to apply the 15 percent capital gains tax rate to estates worth more than $5 million; Senator Obama proposes a 45 percent tax on estates worth more than $3.5 million, the parameters currently scheduled to apply in 2009. Obama’s plan would preserve about 60 percent of current-law estate tax revenue while McCain’s plan would slice revenues by about four-fifths compared with current law. Beyond the candidates’ plans, Congress has considered other options. Legislative proposals range from complete repeal of the tax to less sweeping changes that would provide larger exemptions for family-owned farms and small businesses—two politically sensitive groups—or allow couples to split a joint exemption.
Measuring the distribution of estate taxes requires an assumption about who actually bears the economic burden of the tax. Different assumptions about why people leave estates to their heirs yield different conclusions about the incidence of the estate tax. We follow convention by assuming that the tax falls entirely on decedents. We apply that assumption in a model of the estate tax calibrated to match actual tax collections reported by the Internal Revenue Service. Our model allows us to examine both the revenue and distributional effects of the current tax and a range of proposed changes.
After reviewing the current wealth transfer tax rules and the changes introduced in 2001, we offer an overview of our modeling methodology. We then use the model to estimate the number of estate tax filers, taxable returns, and the distribution of burden under current law. Finally, we investigate the revenue and distributional effects of several proposals to reform the estate tax, including those put forth by the presidential candidates.
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