DEATH TAX RESURRECTION
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The estate levy will rise to 55% in 2013 if Congress does nothing.
For all the worry in Washington and Wall Street about the January tax cliff, almost no one is paying attention to the impending reincarnation of the death tax. This is one more tax increase that will live or die depending on who wins on November 6.
Thanks to the Bush-era tax cuts, this much-loathed levy fell to zero in 2010, but President Obama insisted on bringing it back and Republicans compromised with him after the 2010 election on a 35% rate and a $5 million exemption for 2011 and 2012. In 2013 the rate is scheduled to rise all the way back to 55% with a meager $1 million exemption—where it was in 2001. Americans who have worked a lifetime to accumulate $1 million of savings or other assets will be surprised to learn that Washington thinks they are plutocrats.
Mitt Romney wants to repeal this wealth grab once and for all, while Mr. Obama now proposes a 45% rate with a $3.5 million exemption. Even that is too low for some Democrats in Congress. The President declared in debate that killing the estate tax is another Romney tax cut for the rich. But new research on the fiscal and economic effect of the death tax underscores how wrong Mr. Obama is.
The revenue generated by the estate tax is too trivial to make even a dent in the $1.1 trillion deficit. In 2011 the tax raised a scant $7.4 billion and the best estimate for fiscal 2012 is about $11 billion. This is less than 0.5% of federal tax collections and is enough to run the federal government for one day. Adding to the folly is that fewer than half (44%) of estate tax returns have any tax liability. These families have to bear the compliance costs of the tax even though the government nets nothing.
It’s worse than that because the nonpartisan Tax Foundation calculates that the death tax is a long-term revenue loser. “Tax revenue is likely to increase” upon repeal of the tax, the Foundation finds. At least three other recent studies agree. How is this possible?
First, repeal or even a substantial reduction would be coupled with elimination of a provision called the “step-up basis at death” for calculating capital gains. This “angel of death” policy means that heirs get to revalue the assets at the market price when the owner dies. Thus the appreciation of unsold assets until death escapes capital-gains tax.
If the death tax were abolished, the capital-gains tax would be applied to all unrealized gains from the sale of an asset. That’s a fair and economically beneficial trade: There would be no grave-robber tax imposed at death, but all gains from a business or stocks or real estate would get taxed at the capital-gains rate (now 15%) when eventually sold by the heirs.
Abolishing the estate tax would also mean higher income-tax revenues. Under current law, billionaires like Warren Buffett and Bill Gates escape the tax by diverting their wealth into charitable foundations. But when income-generating assets are sheltered in this way, these foundations with a few exceptions don’t pay tax on the future income from dividends, capital gains or interest. Eliminate the death tax and fewer people will shelter their money in foundations, meaning the money will continue to earn taxable income.
Most important, because the estate tax is a penalty on saving and capital investment, the economy grows more slowly over time. This is why so many industrialized nations, including Canada and Russia, have thrown out this tax as more trouble than it is worth.
Consider the perverse incentives of the tax. When a business owner begins to consider retirement with perhaps $10 million of lifetime wealth, he can reinvest the profits in the business (which means growth and more workers) or live lavishly in retirement and spend the money down to zero.
In the first case, he is smacked with federal and state death taxes that can take away half of the wealth. In the second instance, he pays no tax. A new study by the Joint Economic Committee Republican staff estimates that because of this disincentive to save and invest “the estate tax has cumulatively reduced the amount of capital stock in the U.S. economy by roughly $1.1 trillion.”
The strongest case against the death tax is moral. The levy makes Uncle Sam up to a half-partner in the proceeds of successful businesses. That is on top of the property and income taxes and other assessments that owners pay year after year. Mr. Obama is so obsessed with redistributing income that he thinks it is unfair to leave behind a family business for the kids. What is truly unfair is when a family-owned enterprise has to be sold at auction to pay the death tax to the IRS.
Mitt Romney was right when he told a gathering in Van Meter, Iowa earlier this month that “we ought to kill the death tax. You paid for that farm once. You shouldn’t have to pay for it again.”
A version of this article appeared October 29, 2012, on page A20 in the U.S. edition of The Wall Street Journal, with the headline: Death Tax Resurrection.
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