From: Zhang, Yangkun (Yangkun.Zhang@FMR.COM)
Date: Wed Oct 18 2000 - 11:48:52 PDT
What you will read here is the "Quick Study" of the long report, which runs
29 pages, and should be read by every tax accountant in the country. To get
the long report, go to
THE CASE FOR BURYING THE ESTATE TAX
A Summary of IPI Policy Report #150
By Gary and Aldona Robbins, Senior Research Fellows
Until recently, estate taxes were the exclusive headache of the super rich,
their tax attorneys and their estate planners. However, a strong economy,
an ever-widening distribution of wealth -- both positive developments --
coupled with short-sighted tax policy are extending the grab of estate
Estate taxes even threaten the middle class. Average Americans who
purchased homes 20 or 30 years ago, own a farm or built up a family
business could find their estates large enough to be taxed. And high
marginal tax rates (from 37% up to 55%) often force heirs to liquidate
assets to pay the estate tax bill.
Not surprisingly, the plight of family farms and businesses has caught the
attention of policy makers. Over 50 bills dealing with estate taxes were
introduced during the 105th Congress. Proposals ranged from relief directed
to specific groups of taxpayers, such as farmers and closely-held
businesses, to the elimination of estate and gift taxes. More proposals
will undoubtedly be considered during the 106th Congress.
Until the 1920s estate taxes were used as a sporadic, and temporary, way to
finance wars. When hostilities ceased, the tax was repealed.
From the 1920s through the 1940s estate taxes became another weapon in the
arsenal to redistribute income. Confiscatory tax rates of up to 77 percent
on the largest estates were supposed to prevent wealth becoming
increasingly concentrated in the hands of a few. [See Figure 1.]
Loophole closing preoccupied tax reformers during the late 1960s and early
Lower income tax rates enacted in 1981 were extended to estate taxes and
the exemption was in- creased to remove smaller estates from the tax rolls.
Since then, estate taxes have been on the rise, this time a weapon in the
arsenal to fight federal deficits.
Time has seriously eroded the value of the estate tax exemption. In 1916,
estates under $9 million (in today's dollars) would not have been taxed.
Contrast that with the $600,000 exemption in place since 1987. As a result,
increasing numbers of middle income Americans face the prospect of having
their heirs presented with an estate tax bill. [See Figure 2.]
The Estate Tax Today
Nominally, tax rates start at 18 percent on taxable estates of less than
$10,000 and rise to 55 percent on taxable estates over $3 million. In the
thirteen years since this schedule was put in place, asset values have more
than tripled. But, because bracket amounts are not indexed, more estates
hit the top tax bracket today than ten or fifteen years ago.
The unified credit of $192,800 translates into an exemption amount of
$600,000. Although the tax schedule gives the impression that the estate
tax starts at 18 percent, in fact, the unified credit means that most
people will begin paying at a marginal rate of 37 percent on the first
dollar of taxable estate.
Who Pays Estate Taxes?
In 1995, 69,722 estates were required to file an estate tax return. Almost
a quarter of those returns reported the size of gross estate to be under $1
million. Over half reported estates under $2.5 million and 96 percent under
Less than half the estates filing returns owed tax. Over half (54 percent)
of the $11.8 billion in tax was collected from estates valued at less than
$5 million. Estates worth between $5 and $20 million paid 29 percent of the
tax while those over $20 million paid 16.9 percent.
Changes between 1945 and 1995
While the U.S. population quintupled in the last fifty years, estate tax
returns increased tenfold. As a result, smaller estates make up a much
larger share of total returns today that in 1945 (88.7% versus 33.4%).
Because exemptions levels have not kept up with asset values, more smaller
estates must file returns.
In short, estate taxes are more likely to affect small to medium-sized
estates today than fifty years ago. While the top tax rate is lower today,
it hits much sooner, subjecting relatively small estates to high marginal
How Estate Taxes Affect the Economy
People save for two reasons -- either to consume in the future or make
bequests. Estate and gift taxes hit the latter directly.
Lawrence Summers, now Deputy Secretary of the Treasury, has estimated that
about half of all saving is directed toward bequests. As shown earlier,
estates today face marginal tax rates between 37 and 55 percent. Because of
the huge part that bequests play in saving, these high estate tax rates
discourage saving which, in turn, leads to less investment, slower economic
growth and lower tax revenues.
Why Estate Tax Rates Matter
Taxes affect growth by changing the aftertax returns to the factors of
production -- capital and labor. If taxes are cut, the aftertax return on
the next dollar of invested capital goes up, and investors supply more
capital. Because estate taxes are tied to asset values, they act primarily
on capital, with higher tax rates raising the cost of capital and lower tax
rates reducing the cost.
For the economy to produce the most output at the lowest cost, average and
marginal tax rates should equal each other. Economy-wide, the marginal
federal estate tax rate is 2.8 times higher than the average rate while
that for state and local governments is 1.9 times higher. Putting the two
together, the marginal estate tax rate on U.S. capital are 2.6 times higher
than the average rate. Because marginal estate tax rates are much higher
than average rates, economic efficiency suffers.
Medium-sized Estates Pay the Highest Tax Rates
In 1995, estates over $20 million paid an average tax rate of 12.5 percent.
But the highest average rate -- 17.4 percent -- fell on estates between $5
and $10 million. Close behind, estates between $10 and $20 million paid an
average rate of 17 percent. [See Figure 3.]
Who are most likely to have medium-sized estates that pay the highest tax
rates? Typically they are owners of small businesses and family farms who
amass wealth during their lifetimes through hard work and thrift. Because
wealth is often unexpected, these people may not take full advantage of
ways to reduce estate taxes. As a result, those who come late, or not at
all, to estate planning end up paying most of the tax. In contract, the
very rich, particularly those with inherited wealth, routinely plan ways to
mitigate the death tax and pay lower estate tax rates.
All told, estate taxes are detrimental to the economy. Added to income
taxes, estate taxes can bring the total tax rate on new investment to 100
percent. Small business -- which have fueled much of the current expansion
-- are hit particularly hard.
What estate taxes cost society
We estimate that eliminating the federal estate tax would reduce the
average, economy-wide marginal tax rate on all U.S. capital by 0.25
percent. This lower tax on capital would raise the return to savers and
Eliminating the federal estate tax in 1999 would cause the economy to grow
faster than the baseline, mainly due to a more rapid expansion of the U.S.
stock of capital. By the year 2010:
*Annual gross domestic product would be $137.2 billion, or 0.9 percent,
above the baseline.
*The stock of U.S. capital would be higher by almost $1.7 trillion, or 4.1
percent above the baseline.
*The economy would have created almost 275,000 more jobs than in the
*Between 1999 and 2010, the economy would have produced almost $1 trillion
more in GDP than otherwise.
Boost to Growth Would Ultimately Benefit the Treasury
One major protest against eliminating the estate tax will undoubtedly be
the loss of revenue to the federal Treasury. However, there are several
reasons why this argument doesn't hold water. First, estate taxes are a
minor source of federal revenue. In 1995, the $11.8 billion in estate taxes
amounted to less than one percent of federal revenues..
Second, the estate tax imposes extremely high compliance costs -- about as
much as the tax raises. Tax compliance adds nothing to output and diverts
resources away from productive activities that do.
Third, doing away with estate taxes would produce positive economic growth
effects large enough to offset most of the static revenue loss.
* Between 1999 and 2008, eliminating the estate tax would cost the Treasury
* But the over $700 billion in additional GDP would yield $148.7 billion in
higher income, payroll, excise and other federal taxes.
* In other words, higher growth would offset 78 percent of the static
revenue loss over the first ten years.
* By 2010, the dynamic revenue gain from eliminating the estate tax would
be enough to offset the annual static revenue loss completely.
Bang for the Buck
Reducing estate taxes would generate sizable economic gains with little
revenue loss. Over the next ten years, doing away with the estate tax would
produce $3.67 in output for every dollar of static revenue loss. Longer
run, the relative gains from the faster rate of capital formation would be
even higher. [See Figure 4.]
The high economic payoff makes reducing the estate tax an excellent
candidate for a pro-growth tax cut. And elimination of the estate tax
should be one element of any broad-based tax reform that aims to reduce the
double taxation of saving and investment.
Estate taxes have increasingly reached into middle-class America over the
last several decades.
The largest estates do not pay the highest tax rates. That dubious honor
falls on medium-sized estates, often belonging to people who have started
and shepherded successful businesses.
Estate taxation hurts the economy. Its sheer complexity results in high
compliance costs -- as much as estate taxes raise by one estimate.
Estate taxes have hit small businesses particularly hard. Heirs sometimes
must liquidate at least part of a successful enterprise to pay the estate
High marginal tax rates on estate assets raise capital costs and depress
saving and investment. Almost any move to reduce estate taxes should more
than pay for itself through higher growth.
All in all, American taxpayers, the economy and government would be better
off without estate taxes. Serious reduction or outright elimination of
estate taxes would be one of the best legacies that the 106th Congress
could leave future generations.
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