Last week House Speaker Newt Gingrich proposed abolishing the estate tax. Many other Republican politicians, and some Democrats, have done the same.
The estate tax is imposed on assets passed on to heirs when someone dies. It is the only federal tax on wealth--as opposed to income or consumption. Congress imposed it in 1916, mainly motivated by Progressive Era concerns about the concentration of wealth in the coffers of a few families.
The estate tax is progressive--that is, the tax rate is higher on larger estates. The first $600,000 is exempt. A couple can, therefore, pass on $1.2 million tax-free to their heirs. The rate is 37 percent on amounts between $600,000 and $750,000. The highest rate is 55 percent, and kicks in at $3 million. But any amount inherited by a spouse is exempt. Pre-death gifts of up to $10,000 a year per recipient are also exempt. Thus, a couple with two children can pass on $40,000 a year tax-free. (Lifetime gifts above the exempted amount are subject to the gift tax, which more or less parallels the estate tax.)
Creative accounting also reduces the estate-tax burden. Deductions, which include administrative costs and charitable gifts, are ample. The tax is based on property's "fair market value," which is a malleable concept and notoriously underestimated by professional estate appraisers. Squabbles between the IRS and estates over fair market value are routine and often protracted. Trusts and other complicated devices are also used to reduce the tax on large estates, although Congress has eliminated many of these opportunities and the IRS has been scrutinizing others more closely in recent years.
The estate tax affects few. Last year, 69,772 estates with assets of more than $600,000 filed forms with the IRS. The combined value of these estates was $117.7 billion. However, because of credits and deductions--mostly transfers to spouses--only 31,918 estates paid the government any money. That's 1.2 percent of all estates. The IRS collected $17.8 billion. According to calculations done by the group Citizens for Tax Justice, 95 percent of the $17.8 billion came from estates valued at more than $1 million. Last year's numbers are similar to the data from the last several years.
Proponents offer three reasons for the tax: 1) It reduces concentrations of wealth, however slightly. 2) Because of the charitable-contribution deduction, it spurs giving. Estates donated $8.2 billion to charity in 1992--almost as much as the $10.1 billion they paid to the government. 3) The tax provides revenue--though this adds up to only 1 percent or 2 percent of total federal revenues in a typical year.
Staunch opponents of the estate tax include farmers. Family farmers often possess highly valued land, but little cash. Consequently, they say, inheritors of farms must sell their farms to pay the tax. However, according to the IRS, only one in 25 farmers leaves a taxable estate. The inheritors of such estates pay very little. In 1992, the median estate tax paid by farmers was $5,000. Much of the value of inherited land is offset by the deduction of debt. Farmers and owners of small businesses also enjoy special exemptions. For instance, their heirs may pay off the estate tax over 14 years at very low interest--an option not available to others.
Many political conservatives argue that the government taxes an estate's assets several times over--first when the money is earned, then when it is invested, and finally when it's transferred to heirs. They call the estate tax an exercise in class warfare, and argue that it drains money from private investment. Some left-of-center economists have made similar arguments. Former Federal Reserve Board Vice Chair Alan Blinder and former chairman of the President's Council of Economic Advisers Joseph Stiglitz argue that: 1) the estate tax fails as a redistributive measure because rich people have become too good at circumventing it; 2) the considerable effort put into circumventing the tax wastes economic resources; and 3) the tax encourages consumption, instead of savings and investment.
Death is not all bad news taxwise. The capital-gains tax on inherited property is based on increases in value only since the property was inherited. Thus, billions of dollars of profits on stocks, real estate, etc., escape the capital-gains tax every year when the owner dies. Some have suggested a trade-off: End the estate tax but tax capital gains at death.