Asymmetrical Information

The inheritance tax may not be fair, but neither is the distribution of whopping big inheritances.

It's a bit much for Paris Hiltons to be complaining that the tax is unfair, when they're perfectly okay with unfairness that works in their favor.

And there's always the good old argument that the estate tax is protection against the creation of a bloody useless aristocracy in America.

" The estate tax is a wealth tax with rate brackets significantly higher than 30%. "

So?

Given the array of methods to shelter assets from the estate tax, why *not* tax the unsheltered funds higher, to make up for the loss?

You can't honestly believe the Bushes and Hiltons and Cheneys will stop using such shelters if the tax rate is dropped to 30%.

"The end result of repeal is that taxes on appreciated assets will be paid, but death will no longer cause forced liquidation of illiquid assets, privately-held businesses in particular."

Sounds like creative destruction to me, the kind that economists are usually so fond of. Face it, the Hilton family has lots of assets which could be put to more economically productive use in other hands than Paris and Nicky's. Likewise, the Bush family has assets that could be better utilized by brighter lights than Neal.

Just think about the Bush compound in Kennebunkport, turned into condos. Ka-ching! Much better, economically, than the current use as the playground of the privileged.

It's funny that economists seem to be so *very* sympathetic with the needs of the oppressed rich, but when the masses are faced with cold, hard reality, their veins run with icewater.

"The death of a company founder/owner is a terrible time for rational decision-making. Yet the future of an enterprise, the current valuation of the business and many ordinary jobs often hang in the balance as the relatives grieve, squabble and fight off vultures."

Wahh wahh wahh. Imagine how they'd feel if they were one of their uninsured, underpaid employees, and had to figure out *every week* how to make ends meet, dreading their old age because they haven't been able to afford to put any money away for retirement.

There seems to be an obvious Marxist influence underlying many of the comments on the last post, which is not surprising because the influence runs throughout the thinking of the world. The whole notion of "fairness" in how money is "distributed" seems pretty indicative of fixed-pie thinking.

The sad thing is that it's largely the wealthy who create more and more wealth for *everyone*, yet because of Marx's influence, people see the wealth of the rich as taking away from their own.

Or, people just get caught up in the pure envy of the media-driven anger over the wealth gap or wage gap or whatever it's being called. Take two workers, one who makes $10,000 per year, and one who makes $100,000 per year, and give them 10% raises every year for five years. The gap will get larger and larger over time, but the rich will get richer and the poor will get... richer.

Prices don't get driven up because there are more rich people, so *apart from envy,* can someone give me a good reason why it's fair (or makes any economic sense) to deplete the wealth of the rich?

M. H. Dreck-

Congratulations on an excellent post that actually demonstrates knowledge of the subject at hand. Please consider stapling a copy to Little Matty Yglesias' forehead.

Jon H-

I hear Oliver Willis calling. It's time for you to go home.

> Given the array of methods to shelter assets from the estate tax, why *not* tax the unsheltered funds higher, to make up for the loss?

Not all estates are equally sheltered.

It's not surprising that the folks who claim to be so concerned about the plight of the "little man" care nothing about his job. A small biz killed for taxes has a greater effect on its employees than it does on its previous owners' heirs. Said folks are so consistent in their advocacy of policies to hurt the little guy that you'd almost think that that's more important to them than their redistributionist ideals.

Mindles,

So you are willing to see your taxes go up to pay for this? Do you think the population in general will as well?

"And there's always the good old argument that the estate tax is protection against the creation of a bloody useless aristocracy in America."

Yeah, and that good old argument is always crap.

Rich people are not the enemy. Even rich people that do nothing but live off their daddy's money are not the enemy. If nothing else, they serve as beta testers for the toys that, if they prove their value and the regulators don't prevent it, will be everyday mass market items for your kids.

If all goes well, those rich people will be beta-testing suborbital joyrides, helping people work the bugs out of the craft and demonstrating the profit potential inherent in making cheaper craft that the non-rich can afford to ride in.

"Sounds like creative destruction to me, the kind that economists are usually so fond of. Face it, the Hilton family has lots of assets which could be put to more economically productive use in other hands than Paris and Nicky's."

And it will be, as more economically productive people buy those assets and Paris gets cash in exchange which she uses to fund her frivolous lifestyle.

As I indicated, I question whether it has to be "paid for" - taxing the capital gains instead will probably end up a more predictable and reliable income stream. Just as people underestimate the amounts in qualified plans that will be taxed in the future, they underestimate the gains embedded in shelter vehicles that would be unwound with repeal.

However I'll bite: I do prefer other methods of taxation - consumption and income based. The old 'super IRA' plus income tax idea works for me - what Reagan was originally proposing in 1986. I think any form of property/wealth tax is prone to the same sorts of problems as the estate tax - one may not have the liquidity to pay it, and appraised value is sometimes a transitory thing.

I don't think anyone should have to give up more than a quarter of their income to taxation, regardless of circumstance. Up to that, however, I'm malleable. I'm in the top tax bracket, and I'd be pleased to see a system that forced me to pay a straight 25% and give up all the deductions and other crap - even though I have the potential now to occasionally game it lower (and we really had that ability prior to the 1993 and 1986 reforms).

The AMT is actually pushing us closer to that outcome, but its selectivity in allowable vs. non-allowable deductions is BS. Get rid of them all. Stop subsidizing the high-tax states with state tax and muni bond deductions.

Yes, I'm a homeowner, and my mortgage is not yet fully paid. And I live in a high-tax state,a nd I own municipal bonds. So I am indeed saying "gore my ox". For major simplification I would pay and dance a jig.

If we are going to continue to concentrate tax revenues in the highest percentiles, there should probably be a constitutional amendment limiting tax rates to 25%. It certainly seems to hit the sweet spot of popular ideas of fairness. Then we can argue about right-sizing government with the resulting (generous) revenue ceiling.

If one cannot discern the essential difference between capital reallocation that takes place as a result of voluntary transactions, and that which takes place as a result of a transaction coerced by a central political body, in terms of achieving the optimal use of said capital, one should refrain from employing Schumpeter's paradigm.

Also, golly gee, I sure am glad that the estate tax prevented families like the Rockefellers from becomimg aristocratic. Whew! That was a close one!

If the death tax did what it's supporters wish it did Ted Kennedy would be flipping burgers. Last time I checked Ted is not flipping burgers and he has several palatial estates and yachts he can vacation at.

That is just one example of the many out there that show the death tax does not do what it's supporters think it does.

Well, leaving aside the actaul accoutning implications of the Estate Tax Repeal, I'd like repeat one reason why so many people are against the Estate Tax (this is kinda related to the Fairness Discussion) that a Republican legislater stated during some hearings:

"A death in the family should not be a taxable event."

Leaving aside everything else, that sums up my opposition to the Estate Tax. It is ghoulish to think the state will profit by the death of wealty people, and feels unclean and ignoble to set up a tax system where that happens.

Mindles,

Well you are willing to see your taxes go up. But I suspect that many won't. It's like the flat tax that has broad appeal until you explain to people that they will lose their mortgage exemptions and many will see a net tax increase.

Also, do you support getting rid of taxes for lottery winnings?

Part of the reason the rates on high income earners need to be so high is the amount income we are able to hide through various entirely legal methods. It needs to be 33% or more when we are able to hide so much. Lots of wealthy people with good incomes that I know pay little or no taxes, esp if they are investors/business owners and are not employed, but rather employers.

Its amazing what a few llcs, corps and partnerships can do.

google 'asset protection'. some are bunk - some are not.

The death tax is another one of those programs the liberals love because it is aimed at the wealthy. Unfortunately it rarely hits the idle rich because they have a battalion of lawyers to structure estates, trusts, and insurance to make sure poor little Paris never has to work a day in her life.

The tax ends up hitting those who have worked hard and put together a thriving small business. For example say a mother and daughter start a family business. They work long hours, make many personal sacrifices to help the business and grow it into a thriving enterprise.

If they have not done their homework (we are hard working family people, the estate tax can't possibly impact us) and the business is in the mothers name and she dies guess what happens. 30 % of the hard work and sweat equity the daughter put into the business disappears in a puff of IRS generated smoke.

That may not kill the business right then. The business will stagger on for a while but the 30 % loss of assets will eventually kill it.

So a tax aimed at the Paris Hilton's of the world ends up hitting everybody but the Paris Hiltons of the world.

GT,

How about we cut spending instead of raise taxes? Or is the concept of having the government spend less of peoples hard earned money completely foreign to you?

First program to go should be farm subsidies. This should make you happy because the subsidies tends to go to those who have more money and assets then the average US citizen. Farm subsidies are a perfect government program, tax those who have less and give it to those who have more!!

As a bonus ending farm subsidies would really help raise the standard of living in many poor third world countries.

Surely there are at least one or two forms of corporate welfare (tax abatements for wal mart?) that you could support ending.

GT,

Believe it or not often times inheritance is not like a lottery. Many people who inherit things have put in a lot of work into growing the asset they eventually inherit.

Since the protection of property and property rights is one of the bedrock functions of government it seems to me that it would not be at all unfair if ones tax liability were some ratio to the amount of properity one owns. Adam Smith said pretty much the same thing.

“The expense of government to the individuals of a great nation is like the expense of management to the joint tenants of a great estate, who are all obliged to contribute in proportion to their respective interests in the estate. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation.”

Adam Smith, The Wealth of Nations, 1776

The problem, as many have pointed out, is that a wealth tax would be unimaginabally complex and prone to all kinds of mischief. On that basis I would not support a broad based "wealth" tax. However that does not mean that such a tax is inhearently unfair, it simply means that it can't be crafted into a practial proposal for taxation which is an entirely different argument. But what is revelent to the discussion is the notion of what is fair taxation or more specifically the notation that "the rich™ " should sholder a larger % of the tax liability is somehow inherently "Marxest™ ".

For me the notion that all proposals for "the rich™ " to sholder a higher % of the overall tax burden are born of "Class Envy™ " is completely irrelivent. Maybe they are, but I fail to see the relivence since one could make the equally dubious claim that all proposals for lowering taxes on "the rich#153;" are born of "greed#153;" or some other slur.

So the question I would like to see addressed is why is it fair that a person with assets totaling 20k should have to forke over close to 50% of that amount in taxes, while someone worth 500 million is only required to pay 10% of that amount? Why exactly is that "fair". The 500 million person has a much bigger intrest in sustaining the framework that allows such fortunes to be persued then the 20k person.

Rick - so you're saying why is it fair that one (theoretical) guy pays only ten thousand dollars but the other theoretical guy pays $50 million?

As an aside, many people get upset at rich people who have large amounts of muni income tax free, like Ms. Kerry, where they calculated she paid about 15% of her income. What they don't realize is that her GROSS income was already lower because munis pay less. So her 'taxes' on this income were paid directly to the issuing states in the form of an interest subsidy. Those implicit taxes would have to be added back to the numerator to show what she actually gave to the states and make an 'apples to apples' comparison. Properly measured, she has a higher effective tax rate.

These comments prove once again that Socialism is alive and well in the US and will eventually destroy us. To those of you who believe in progressive taxes, etc, please re-read the story of the Golden Goose. Stop off at the Little Red Hen if you have the time. Not that I expect you to get the point but that is truly the level of what needs to be understood about Socialism to oppose it.

I would only add my reply to the second 'clever' question that an inheritance is fulfilling the express wishes of a property owner to convey his assets to another. Yes, it's about property rights.

A lottery ticket is gambling (investing money fully aware that the odds are stacked against you).

Jack,

Point well made. The problem is, many people are socialists in mindset and don't even know it. (nor will they admit it)

The rich didn't work for it! They don't deserve it! Take from the oppressive rich who have built thier fortunes on the backs of poor! (note when they say this, they never back it up, or their evidence is flimsy)

Who is to judge who deserves money they worked for (or money a parent has worked for to give to their slacker child?). You? Me? Some UN Board?

Socialism may sound great, but it never works, and it always fosters the extermination of true freedom. Look around the world, when has socialism ever worked? It just makes everybody EQUALLY miserable.

Mindless,

Are you suggesting that we calculate tax liability by totaling up expenditures and dividing by the number of taxpayers?

I'm pointing out that when you talk about how much people pay in taxes we seem to look at metrics like what % of the "income" tax is paid by the top X income group.

I am also suggesting that hand wringing over the motivations of those behind specific proposals is largely irrelevant.

And finally I'm asking why Adam Smith was wrong in saying that tax liability should be a function of the size of ones assets. Or is the protection of property and property rights not a legitimate function of government? If it is why should those with little or no property be asked to subsidize that function to the benefit of those who have much. Pretty simple questions really.

I would only add my reply to the second 'clever' question that an inheritance is fulfilling the express wishes of a property owner to convey his assets to another. Yes, it's about property rights.

So property owners are not obliged to pay taxes?

You seem to be more comfortable addressing tangential issues while leaving the main point unaddressed.

Mindles,

Lottery is also about fulfilling the express wishes of the owner. So is receiving your income. Yet we tax all those events.

we learn there is no injustice in taking things from people who don't deserve it.

By an amazing coincidence, I'm currently reading Burke's Reflections, and indeed the very section that talks about the sheer injustice of the General Assembly's confiscation of wealth and property from those they have decided no longer "deserve" them, regardless of age-old claims backed by law and tradition unbroken for centuries (like, oh, inheritance).

The more things change...

(Note: The side of the Revolution is not the one you should want to be comfortable being on, in this case.)

One of the posters suggested that there would be the same amount of effort to avoid a 30% estate tax as there has been to avoid a 55% estate tax. Another suggested that high marginal rates are needed to make up for the fact so much effort is put into hiding taxable income from the government. Let me address both these points from my personal experience. After the 1986 tax reform, the highest marginal income tax bracket was 28%. The demand for tax planning almost dried up overnight. It was a bad time to be a tax professional. Almost all tax work was in preparing returns (which the 1986 act made more complex), not in planning. Unfortunately, clients didn't see any additional value in having their returns prepared, so you could not fully recover the additional time it took to prepare the returns. Profits from tax practice dropped like a rock. Then Bill Clinton came into office. God bless the man! Marginal rates went up close to 40% and tax planning was back! That man saved my career.

What does this experience teach me? Most people are willing to pay a "fair" tax and are unwilling to take "unfair" steps to avoid paying one. While some are willing to avoid even a fair tax, there are NOT enough of them to make gaining the skills necessary to serve them worthwhile. But, raise the rates or otherwise make the tax seem unfair, and and there are many people who are willing to pay a lot to make the system more fair. In that environment, it's fairly easy to create a profitable business in tax planning. It's seldom a purely dollars and cents type decision. A lot of emotion is involved and taxpayers often motivated to engage in planning out of a sense that the tax system is treating them unfairly.

Note: By "planning" I am NOT suggesting doing anything that is not allowed by the law in anyway. I am talking about taking legitimate steps that, while the IRS might not like them, the IRS will not challenge them, either.

What's the beef about Paris Hilton? Unless she's
stuffing all her assets in a mattress, then those assets are invested and working to provide jobs for others. How many "little people" benefit everytime the little twit blows big $$$$ on a catered party? As one economist once said, "every dollar is a certificate of appreciation" that the uncoerced public (consumers) have voluntarily voted to bestow on
another. If you don't want to bestow any more awards on Hilton, start staying at the Marriott.

Hey Rick, since when do you get to decide what 'the main point is' that I should address by simply declaring it in the comments?

The post conveys my main points - a large chunk of people complaining abour repeal don't understand the mechanics and don't understand why many find it unfair. Most of your questions are red herrings raising issues not addressed in the post, but in others comments, such as 'handwringing about motivation'.

Nice try. You dictate the discussion on your own blog.

Keynes pointed out that the modern West owes its great and totally unprecedented rise in wealth to the appearance of a new kind of rich such as the world had never seen before -- rich who saved and accumulated capital rather than consume their wealth.

Today one thing economists of near all camps agree on is that there is a dearth of savings and capital accumulation -- especially with the huge entitlement costs coming done the pike.

And the purpose and function of the estate tax is to seize accumulated savings and capital and have it be consumed by the government. Which is b-a-d -- especially now.

"As long as an inheritance tax remains a true inheritance tax, it always involves a conversion of capital into income, hence an act of economic waste which is damaging to all." -- Joseph Schumpeter.

"It's a bit much for Paris Hiltons to be complaining that the tax is unfair"

As long as Paris keeps her wealth invested she is one of Keynes' rich who are helping to finance the economic growth needed to pay your future entitlement benefits. The thing to tax her on is her consumption.

And as for what's "a bit much", how about liberals saying that letting the rich simply keep their own wealth is bad and regressive -- but taxing working people to make transfers to the rich through Social Security and Medicare is good and progressive!

Just how credible is it to play the class warfare estate tax card against Paris, while at the same time defending the great societal need to have Warren Buffett collect his medical expenses and Social Security pension from his Dairy Queen employees?

I'll take a liberal's class warfare argument on the estate tax seriously when I hear it come from one who uses the same argument to propose ending transfer payments to the rich.

Until then it is a transparent charade.

"Since the protection of property and property rights is one of the bedrock functions of government it seems to me that it would not be at all unfair if ones tax liability were some ratio to the amount of properity one owns. Adam Smith said pretty much the same thing. "

If the government spent more than a few percent of its budget on protecting property rights, this might make sense.

But since the overwhelming bulk of the budget is consumption, subsidies and transfer payments -- entirely different from Adam Smith's day -- it doesn't.

I don't see any more of a problem with an estate tax in principle than I do with a property tax. Eliminating property taxes makes it a bit too easy for large tracts of land to just go idle permanently -- an analogous risk exists for large estates.

While a few commenters point at Rockefellers and Kennedys living off inherited fortunes even in the face of the estate tax, the point is that an estate tax at least accelerates the geometric decline in value of those fortunes, so they might not be so prominent in the 24th century (and if they are, that would be because they continued to do real work in the meantime). If there is no geometric decline, that's a problem with the implementation of the estate tax, not the principle.

I freely admit there are serious problems with the estate tax's implementation. Mindles has a very good point with the 25% "psychological sweet spot" rate; the marginal rate should go down to reduce avoidance behavior (and more importantly, the initial exemption should definitely go up, to at least $10 million if not a lot more; the estate tax was NEVER intended to hit family businesses). On the other hand, I'm not sold on the current proposal to repeal the estate tax entirely while stepping up capital gains bases; the "property tax" effect of geometric decline in estate value across the generations is lost, unless I misunderstand the legislation.

(Totally unrelated comment: the email address field does not accept digits. Since there actually are digits in my real email address, this forces me to enter a false one.)

Mindles said:

"As an aside, many people get upset at rich people who have large amounts of muni income tax free, like Ms. Kerry, where they calculated she paid about 15% of her income. What they don't realize is that her GROSS income was already lower because munis pay less. So her 'taxes' on this income were paid directly to the issuing states in the form of an interest subsidy. Those implicit taxes would have to be added back to the numerator to show what she actually gave to the states and make an 'apples to apples' comparison. Properly measured, she has a higher effective tax rate."

This was most likely a response to my previous comment contrasting THKerry's tax rate with her husband's proposed increase in the income tax rate. You assumed that my comment was based on my ignorance of the relative pricing of muni to taxable bonds - you're wrong about my ignorance, you simply missed my point. My point was that income taxes have the worst impact on economic growth, and that's a point that Kerry tragically missed by calling for such a stupid move like raising income taxes. His rhetorical arguments against the rich smack of insincerity when contrasted with how that tax increase would affect the really rich (his wife as a convenient example). As Mark Twain said, "Don't assume, it makes an ass of you and me."

that being said - I agree mostly with your overall desire that tax codes need to be dramatically simplified with all the deductions eliminated, and then 25% is about right it would seem, but my agreement breaks down when you separate estate transfers as being non taxable events.... why?

what your argument against estate taxes boils down to is
1) a moral dividing line between income/sales/investment income as taxable financial events and wealth and estate taxes off limits. I agree with the idea that taxing property tricky because there's no transaction. Your logic breaks down when you lump estate taxes with property taxes. Estate taxes are a transfer of wealth from one individual to another - why shouldn't this be viewed as income to benefactee??
2) the current tax code is still filled with lots of games for people to hire the Mr. Wasler's of the world to find ways to play the games and avoid taxes, and the new changes don't really change the net revenue because of the devilish details.

I haven't heard any discussion of relative benefits to the economy of different taxes, just the above two arguments in different forms. I would argue that payroll and income tax inhibit more productive and probably more elastic financial transations than distribution of investment income or estate transfer. People with money to invest will continue to do so, and people who are rich will continue to age and die like the rest of us.

Please spare me the details about how poorly the current tax code properly taxes these events as an argument to eliminate the tax altogether. That only increases the moral hazard to make really crappy tax code.

This can only be about property rights if dead people have rights, which I think is absurd. What other rights would you give them, Jane?

By coincidence, we covered another response to the idea that it's fairer to tax wealth the other day in my econ class. The argument basically goes: most people plan to retire at some poing (say, 65) and die sometime later (say, 85). So during their working lives, they try to save enough that they can retire at 65--dropping income to near-zero--and continue to consume at roughly the same rate they did before retirement. Thus a person's wealth should peak right before retirement, but the point is that he's equally well-off right before and right after retirement, at least if he's planned it well.

On the other hand, if you tax income, you're screwing him at the beginning of his career, when he has high income and no wealth (possibly negative wealth). He's no better off, and probably worse off, than the equivalent guy right after retirement, when he has no income but lots of wealth to draw consumption from.

The take-home from the model is that neither income nor wealth is a good proxy for well-being. The best proxy is consumption, because how much you're consuming is the benefit you reap from your wealth; and if you assume people try to keep their standards of living roughly constant, it's not lifecycle-biased--that is, it screws neither the person who's just retired and living off wealth saved out of previous income, nor the person who's just started working and has high income but no wealth.

So Jim can we include you in the "I'll gladly pay higher taxes so nobody has to pay the estate tax" group?

The estate tax IS a serious burden for small business with the obvious serios problems occuring for family owned small business.

So increase the estate tax on the top 3% and reduce it for the small business (generally lower to upper middle classes).

The dynamics for employment will be improved, small business will be stronger, and family businesses from pizza parlors to real estate agencies will have the continuity that contributes to a vigorous and more stable economy.

I don't see this view as "liberal" or "conservative." It's one that would work based on my experience in working with small businesses and the too often major problems faced with the owner dies or reaches retirement age and there's no way to pass the business onto a daughter or son who has worked in the business 20-30 years.

Better planning by small business? Certainly that would help, but time to do it and the knowledge it even exists have been chronic problems. Small business does not have a department that looks into tax advantages in this or that or some means of retaining assets to continue the business.

Suprirsingly (to me anyway) small business continues to prosper in many ways, especially in certain business sectors. Eliminating the tax entirely is merely another tax break for the upper 3% income groups which does NOT return the amount of reduction to the economy and keep it healthy. This was obvious from the second Bush income tax reduction where many consservative Republicans weren't all that thrilled with it.

Why add to the present deficit and the problems it portends? Eliminate it for small business and lower to middle class individuals. The time has come to stop believing that the economy is improved in an amount comensurate with the tax cut (or more). In the case of small business in particular I can see it paying dividends, largely through business stability in that sector, in terms of reduction or elimination.

The upper middle class to wealthy classes already have their living trusts, life insurance, and all the other "estate planning" tools at their hands. Not small business. Not the lower or middle classes.

The inheritance tax may not be fair, but neither is the distribution of whopping big inheritances.

What could possibly be more fair than giving someone some of your own money, of your own free will?

It's a bit much for Paris Hiltons to be complaining that the tax is unfair

The Paris Hiltons don't pay the estate tax. There are plenty of ways around it; they're just hard to afford if you aren't rich (if, for example, you wealth is entirely tied up in the business you want your children to inherit).

If dead people don't have property rights, what on earth is a last will and testament?

Tell that to all the class warriors up in Litchfield county leaving their country estates to forever wild.

(and don't call me Jane)

Every person posting here about how bad it is that the estate tax affects small business and that's why they oppose it is pretty much about as hypocritical as the Republicans. That argument is a crock. Why? In an attempt to compromise the point at which the tax would kick in has been upped in proposal after proposal. Every one has been rejected and the Republican response is that it must simply be eliminated. Exactly what the heck do you folks think a small business is, anyway? I've heard proposals as high as $10 million dollars. I've heard of proposals to simply ensure that there can be no dissolution of a business, no forced selling of a farm. These too have been rejected. So please quit trotting out that old canard about saving the small business/farm. It's nothing but a big lie that those possibilities have anything to do with the issue. A farm state Senator dragged that old one out last week. One of those evil, lying MSM (Don't you love how I can use your vocabulary so you can understand it?) pointed out that no one could find one instance of a farm being sold because of estate taxes in his state. Not one.

I also see the old canard about how it's all about socialism, the evil scourge of mankind. While it's true that two of the most tyrannical governments of the twentieth century claimed descent from communist ideals there were far more dictators who had nothing to do with socialism or communism, but instead simply rigged the rules of capitalism to make sure that the wealthy were on their side or brushed close to socialism only to the extent that they paid off enough of the population to keep things stable.

The old rule of thumb, I believe, is "shirtsleeves to shirtsleeves in three generations." With or without an estate tax.

Someone cited the Kennedys and Rockefellers and argued the estate tax will prevent those fortunes from living on into the 24th century. We don't need an estate tax to do that.

The Kennedy fortune is in serious decline, because few if any of the family is working to keep it up. The Rockefellers are in better shape, but then at least through the third generation (David, et al) they have worked to enhance it.

The nature of wealth in America is that it's not static. If the heirs don't work at it, the fortune will melt away. I doubt Paris Hilton's grandchildren will be wealthy, unless she has some industrious siblings or cousins (or she marries well).

I hate it when the right plays the small business card. The government defines small business as any business with less then 5000 employees. Most Americans hear small business and think of their corner store or family owned resteraunt.

I don't have much of a business background, but I would think most business's could borrow against holdings to avoid liquidation due to estate taxes. If they can't, to bad, everyone has to pay their taxes. The whole capital gains later rather then estate taxes now is an attempt to hopefully pay no taxes at all. We are running massive debt because of the tax cuts and a war we chose to fight, we can't just throw the debt on the next generation, yet all I ever read from the right are schemes to avoid paying tax.

"I don't have much of a business background, but I would think most business's could borrow against holdings to avoid liquidation due to estate taxes. If they can't, to [sic] bad, everyone has to pay their taxes. " So Fabulous

Gee, So, do you really think most businesses can afford to borrow up to 50% of their value and continue to operate? Of course they can. They do it all the time. A car dealer borrows huge sums and buys cars for resale. A cabinet shop borrows smaller sums (but still large on a relative basis) and buys new equipment. The baker borrows and buys a new oven. Notice a trend? The business borrows and buys something to help run the business. Borrowing to pay taxes adds NOTHING to the balance sheet but debt. Borrowing to pay taxes adds NOTHING to the income statement but expense. Margins are too thin in most industries to allow a business to survive if it takes on such large expense loads without getting any return from the expense.

Your answer to this government created problem is "too bad, we all have to pay taxes." (This is more diplomatically put than Matt Y.'s F-bomb, but it's the same sentiment. A complete lack of concern for the problems your policy prescriptions might cause.) Yes, we all pay taxes, but the income tax -- since it's based on income and not wealth -- has a FAR smaller chance of killing a business. No income? No tax. So the income tax ties the ability to pay the tax with the tax. The estate tax does not. (Because the income tax is not tied directly to cash flow, the income tax can cause cash flow deficits that threaten a business's survival. This is a far less common problem than with the estate tax.)

My point is that I know why we have an estate tax. It was not ordained by god. Nor was it created to raise revenue. The reason for the tax was to prevent accumulations of wealth within families. The original proponents would have taken the "excess" wealth from the current generation (the Robber Barons), but the Constitution prevented them from doing so. Instead, they taxed the "privilege" of transferring wealth to the next generation. This was bad policy when enacted and it is worse policy today. (Wealthy families really are not wrecking economic havoc on the countryside and the government should not be trying to discourage families from taking care of each other.) Like all bad policy, it should be ripped out by the roots.

Note: I am arguing against self-interest. I will most likely lose my job if the estate tax is repealed. (This is why my wife keeps voting for democrats.)

And, yes, GT, if necessary to make up for lost revenue, raise the income tax rates. I don't admit that would be necessary. As Mindles points out, the lack of a step up in basis would more than make up for any lost estate tax revenue.

GT- nope, not at all. nothing sacred to me about a tax on the transfer of substantial wealth to the next generation, and I don't like paying taxes. Maybe I'd pay a bit more to simplify things.

David - what is the current rate and exemption level? I'm curious how you got to your estimate of a small business needing to borrow 50% of their value to pay estate taxes.... how did you get to that figure?

Jim - The current maximum rate is 47%. There is also, currently, an historically high credit which covers the tax on the first $1.5 million of taxable estate. So, in truth, the percentage is likely to be south of 50%. I hope you'll forgive some rounding on my part.

However, if a family owns a business worth, say $10 million, they may have close to $1.5 million in non-business assets -- such as a home and furnishings in a not-too-ritzy part of California or Virginia. Assuming these non-business assets cannot be easily sold to pay the tax, the business assets need to bear the full burden. So, it's not uncommon -- even with today's lower rates and larger credit -- to find a business burdened with too much debt to survive.

Just two weeks ago I met with prospective clients. They were two sisters in their 60s. Their mother had died and they now owe close to $1 million in estate taxes (due in July). The only asset of any real value is the farm that has been in the family for four generations. I explained that there was a way to reduce the tax (a Sec. 2032A election) and a way to defer the tax payment (a Sec. 6166 election). I believe that, with these elections, they can keep the farm within the family for a few more years. Within five, the farm will be sold. The farm just does not produce enough cash income to pay a living wage and cover the interest on the tax. Selling their mother's home and furnishings will cover the first few years of interest payments.

I don't expect GT, Jim, So, or any of the others who support this tax to cry for these people. Nor would this family expect any tears. I will point out that neither sister is rich. One just retired as a school custodian. The other works as an office manager. One of their sons runs the farm. Maybe the new owners will hire him to farm it for them before it's cut up into home sites. If not, he can always start over. He's young and can easily retrain as a welder or something. I will also point out that neither of these sisters can fathom why this is happening to them. They feel as if the government they've supported and paid taxes to all of their lives has suddenly turned on them. Their head spins from what they perceive as the bewildering unfairness of it all. They are sure that, one day soon, they will wake up from a bad dream and someone will point out the part of the law that exempts them from all this turmoil.

I can already hear the cries of "Creative destruction!" if not "Screw'em. We've all got problems." from the pro-estate tax, soak the rich crowd. Funny, I thought you guys cared about the small guy when the big, bad corporations were throwing people out of work. Why is it okay when the government does it?

GT,

Still can't find any programs you would like to cut to "pay" for eliminating the death tax?

Not even US farm subsidies that have caused so much misery in third world countries?

Cat got your tongue?

David Walser,

Thanks for posting the story. I would hope the death tax would be less popular with the "liberals" if they understood how it actually works.

David - thanks for the info and the story. 47% is high.... I'd prefer it was identical to the highest bracket income rate.

On your story, these sisters are now multimillionaires living on land for which the community/economy has much better uses. Furthermore, their farm has most likely been supported by the average taxpayer through farm subsidies for decades. While their overall situation does seem sad, that seems mostly due to the grieving and confusion. The economy seems a lot better off taking money from them than profitable businesses and working families.

Have they considered what they'll do with their new found millions after selling the farm?

Jim - I do not argue that the land might not be put to a higher and better use. Nor will I argue in favor of farm subsidies (which, in the end, tend to do more for consumers in the form of lower food prices than for farmers). I will argue that I don't think it's a proper role of government to force the sale of under-utilized assets. Else, why not require that all our assets be sold to the highest bidder each year? Someone would be willing to pay more than I could afford for my house, should government force me to sell? Why should my death change the equation?

In the case of my prospective clients, they have a lot of non-economic reasons for keeping the farm. A family member has planned his life around being able to run the farm. The family holds reunions at the farm each summer. Members of the family come from all across the USA to spend a week together, do farm chores, fix up fences and out buildings, and grow closer as a family. Why does the death of the matriarch mandate that all of this should end? Note: The family has been aware for years that they could generate more cash by getting rid of the farm and investing in a money market fund. They've not done so for the reasons mentioned above and more. None of these reasons evaporated simply because Mom, Grandma, and Great-Grandma died. Again, why does death grant government more intrusion into family matters than before? The government will get it's money (in the form of capital gains taxes) once the family sells the farm. (This assumes the estate tax were repealed and the step-up in basis is eliminated.)

Oh, and don't get me started on the gift tax. Why should I have to pay a tax on the privilege of paying for my daughter's wedding? (The cost of the wedding in excess of the gift tax annual exclusion is a taxable gift. As the father of two daughters, I've been told that weddings cost far more than the current annual exclusion, $11,000, would cover. Me? I STILL think a barbeque in the back yard should suffice. I am also told I don't get a vote in such matters.) I've yet to find anyone subject to the gift or estate tax who finds it a fair tax. I know there are some wealthy persons who disagree, but most people just don't think that weddings, graduations, and funerals should cause Uncle Sam to be invited to the occasion as a paid guest.

There's a lot of whining about the deserving rich in these posts. How do they become rich? Part is their hard work, but a farmer in Zimbabwe works harder. They have become rich through working in the US, supported by its structure of laws and economic policy, and supported by the taxes paid by our forefathers which have gone to build that system. How do we propose that those whom fortune has favored support the system in the future? Much of the wealth they would pass on has never been taxed (viz: Bill Gates). They certainly would like the structure which supported them to be there for their descendants.

In closing, remember Matthew 22:17-21.

Never been taxed? You mean Microsoft earnings are exempt from taxation? News to me.

Stock price appreciation can exceed or lag growth in retained (taxed) earnings. Nonetheless, the equity represented by Bill's shares has earned billions of dollars for the U.S. Treasury (as well as Washington and a number of other states and countries). Furthermore, he sells a few hundred million every quarter and pays capital gains tax. This would continue after his death because the basis would not be stepped up, as I indicated in the post. Gates doesn't need to pay estate tax to have made enormous payments to support the 'system'.

Not 'never', not by a long shot.

David - no, I don't think they should be allowed to take your house while you're still alive through tax. I agree completely with you and Mindles on this point about wealth tax.

The point about which I guess we fundamentally disagree (and probably divides most people on this issue) is whether the estate/death tax is

a tax on the living that just inherited a bunch of unearned wealth and would like to see it treated as income for these people

or

a tax on the just deceased benefactor (and that's why the phrase 'death tax' is appealing because if you view it as a tax on the dead person, then you've got them 90% on your side)

and as a side point, if you're throwing the party on her behalf then you're not giving the money to your daughter, and therefore, is it really taxable? It sure sounds like you know the answer better than I would

The other thing I find funny here is the idea that *taking* from the rich for the government treasury is the same as giving it to the poor.

Right.

Considering that there is a $1.5 million exemption before the estate tax starts and it only gradually rises to 47% if they owe a million dollars in estate tax that is some pitiful story David told there. And this terrible interest they must pay for five years is 2%, which they could defer. Current law allows deferral of estate tax payments for up to 14 years when the value of a family-owned business or farm accounts for at least 35 percent of an estate.

(BTW, Dem. Rangel had proposed some farm estate tax and small business relief that looks like it would have made the sister's tax zero but the GOP wasn't interested.)

I noticed it was left out of the story how much these poor sisters would actually receive from this estate.

Did someone else say double taxation? Hardly.

Without the estate tax, capital gains included in an estate would never be taxed. Under current law, the gain from appreciation of an asset is subject to the income tax only when the asset is sold. Upon the sale of an asset, the difference between the purchase price and the sale price is taxed as a capital gain. If a person holds on to an asset until he or she dies, however, the heirs inherit the asset at its value at the time of the decedent’s death. The gain on the asset from the time of purchase to the time of death is never taxed under the income tax.

Some of the capital gains income that escapes taxation under the income tax may be taxed under the estate tax. The appreciated value of the asset is included in the estate and, if the estate is large enough, subject to taxation.

A substantial proportion of assets subject to the estate tax are untaxed capital gains. Estimates made by economists James Poterba and Scott Weisbenner, based on data from the Survey of Consumer Finances, suggest that unrealized capital gains make up about 37 percent of the value of estates worth more than $1 million and about 56 percent of estates worth more than $10 million.

The Agriculture Department estimates that in 1998, fewer than six percent of all farms had a net worth in excess of $1.3 million, the amount of an estate that is completely exempt if the estate includes a family-owned farm. Only 1.5 percent of farms have net worth over $3 million which must be the case in this story.

Estate taxes affect less than 2% of estates but will bring in $300 billion to the Feds over ten years and lastly the overall effective tax rate on estates is lower than the effective income tax rates.

Rather than doing away with the estate tax current proposals before Congress would keep it and dedicate the money to Social Security which seems fitting.

As for Jane's change of basis proposal - There are major difficulties inherent in administering a carry-over basis provision, which are well known. These include ways to attribute the general exemption to the specific assets that are inherited by different heirs and the need to trace original purchase prices of assets through at least two and perhaps several generations. A carry-over basis provision was enacted a little over 20 years ago, but it was repealed before it took effect. According to a Congressional Research Service report, the primary rationale for repeal was the concern that the carryover basis resulted in great administrative burdens for estates, heirs, and the Treasury Department.

Even if the carry-over basis provision were implemented, it would replace only a fraction of the revenue lost as a result of estate tax repeal. A Congressional Budget Office analysis of a carry-over basis proposal that *does not* include the type of large exemptions now present found it would replace only 12 percent of estate tax revenues.

Gary

"Without the estate tax, capital gains included in an estate would never be taxed."

Flat Wrong, as you seem to admit yourself later in your comment. I'm not Jane, and it isn't "(my) proposal", it's Congress' (read the linked SBCA article, for instance). Repeal would eliminate carryover basis. Therefore, capital gains *would* be taxed at the time of liquidation.

I agree carryover is complex, I don't agree with a static analysis of a lower revenue yield (of that magnitude) from taxing capital gains instead of estates. For taxes with rates as high as the estate tax it is critical to consider changes in avoidance behavior. Recent capital gains rate changes have shown that even with more modest rate reductions.

Typical avoidance behavior for the estate tax requires giving up control of assets. Given a reasonable tax rate, or simply the tax timing control of capital gains, most of the folks I know who have engaged in this sort of planning would stop. These are the seriously rich - fifty million and up, who pay little or no estate tax now.

High tax rates just don't work as advertised. Low rates with no loopholes are optimal. And forced liquidation is wrong, even with 3-5 years 'grace'.

Easter - Is your argument that the estate tax should be retained as a backstop to the untaxed appreciation that is included in a lot of estates? Let's look how this might work in practice, using actual numbers. This morning I met with another prospective client. He is the sole owner of a business worth an estimated $310 million. He has income tax basis in the business of $178 million. The untaxed appreciation in this case would be an estimated $132 million. If the business were sold today, this $132 million would be taxed at 15% and he would owe $19.8 million in income taxes. If, on the other hand, he were to die, all $310 million would be subject to tax at a rate of 47% (there are more than enough other assets in his estate to use up lower marginal brackets and credits -- the the extent they are not phased out) and his estate would owe $145.7 million in estate tax. The estate tax is more than 7 times the deferred capital gains tax liability! That's one heck of a backstop. This illustrates a very important fact: the current estate tax is incompatible with the notion that its purpose is to compensate for the "leakage" transfers taking place at death might create in the income tax structure. Particularly when that purpose can be accomplished much more simply by a carry over of basis rule.

The estate tax is a tax on a lack of consumption. In this case, my potential client paid tax on over $200 million of income that he has not used for personal consumption. (The $178 million basis in the business is income earned, on which tax has been paid, that has been retained in the business. Before income tax, the taxable income would have been about $270 million -- assuming an average income tax rate of 35%.) What has he done with this income he's paid tax on? He's left in a business that employs more than 100 workers. If, instead, he had consumed the income in a much higher standard of living, there would be no estate tax or deferred capital gains tax -- nor would there be 100 jobs. Which do you think is the behavior we should encourage, capital formation or consumption?

In essence, the income tax is just a down payment we make each year on our "fair share" in taxes. The government collects the rest of our fair share out of our estate. That's where I come in. One thing's for certain, if this guy hires me and if he lives another 10 years, there won't be an estate tax bill when he dies. (I think this is the avoidance behavior Mindles was talking about.)

Jim and Easter Lemming,

Siblings and children have put decades of their lives into helping a family enterprise increase in value. They have earned much of the value of the family business that would be transferred to them when the owner in title dies.

In the example David Walser gave a family member who worked for years on a farm is going to get thrown off of it. And all the "compassionate liberals" can say is "up yours" give us the money now.

If corporations treated workers the way the death tax treats family members who work in family businesses the liberals would be enraged.

Jim-- Without question, in the eyes of the law, the estate tax is a tax on the estate and not on the beneficiary. Whether or not you agree with that in principle is up to you, but it is fact that the estate is the entity who files the return and pays the tax.

From the IRS website:

"For decedents dying in 2004, Form 706 must be filed by the executor for the estate of every U.S. citizen or resident whose gross estate, plus adjusted taxable gifts and specific exemption, is more than $1,500,000."

DonV - I thought we were debating what the law should be and more specifically, the new bill in congress that Mindles highlighted. Pointing out the current definitions in the law doesn't really change the debate as far as I can see, although thanks for sharing.

TJIT - so are you saying that I'm a "compassionate liberal" saying "up yours" because I think large sums of inherited money should be taxed?

David - what would you estimate the impact to charitable donations would be with the repeal of the estate tax? I assume (although I don't know too much about avoiding estate taxes other than these charitable living trusts) that it will include a benefit to a charity of the business owner's choice.

Does anyone (Jane, Mindles?) want to pick up the issue that I'd most like to look at - what are the relative impacts to the economy of various taxes that the country can choose from to raise revenue?
I'd change my position (of estate tax rate = top bracket income tax rate; or just inheritance goes to the income line on tax return for benefactee) in a heartbeat if someone showed me to wrong in my assumption that the income tax is most detrimental to our economy and other taxes would be preferrable (ideally sales tax + estate tax in my mind)

Jim-- you stated that the question was if the tax was on "the living who just inherited a bunch of unearned wealth" or "a tax on the just deceased benefactor."

From a legal point of view, the tax is on the just deceased benefactor. You can think of it however you want, but the government is quite clear on this point.

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