#TaxReform: 5 Solid Reasons to End the Death Tax
By SBE Council at 14 August, 2017, 4:26 pm
by Raymond J. Keating-
Tax relief and reform is critical for entrepreneurship, small business, U.S. competitiveness and our economy. And it’s important for any reform effort to permanently end the estate, or death, tax.
The Death Tax: A Brief History
The current U.S. death tax was first imposed in 1916 at a rate of 10 percent. The tax rate topped out at 77 percent at the beginning of World War II, and later declined to 70 percent in 1977. The Reagan tax cuts of the 1980s saw the rate drop to 55 percent. The rate was scheduled to fall to 50 percent in 1993, but that cut was eliminated by the Clinton tax increase that year.
Later, the George W. Bush tax relief package saw the rate decline to 50 percent in 2002, then declining to 45 percent in 2008-09, and the tax actually was eliminated in 2010 (specifically, as CCH notes: “35% of excess over $5 million and stepped-up basis for inherited assets, or election for no estate tax, but carryover basis for inherited assets”). Subsequently, the death tax rate increased to 40 percent from 35 percent in 2013.
In addition, in 2013, a $5 million exemption level was put into effect, up from $3.5 million in 2009, and indexed going forward. The exemption level is $5.49 million in 2017.
Five Reasons to End It
There are several major problems with such a tax, which make clear the case for its elimination.
1.) The death tax is inefficient in raising revenue.
Federal estate and gift tax revenues account for approximately 0.6 percent of federal receipts (ranging between 0.57 percent and 0.68 percent over 2012 to 2016). When accounting for compliance costs and lost economic output, death and gift taxes provide no net revenue to the federal government.
For example, a June 2003 study from the Joint Economic Committee in Congress (“The Economics of the Estate Tax: An Update”) noted that the negative impact of death taxes depresses income tax revenues: “The estate tax raises very little, if any, net revenue for the federal government. The distortionary effects of the estate tax result in losses under the income tax that are roughly the same size as estate tax revenues.”
Also, a 2011 study by Stephen Entin for the American Family Business Foundation found: “According to the dynamic score employed in the brief, the estate tax would increase Gross Domestic Product by about 2.25 percent, private sector output and labor income (hours worked times hourly wage) by about 2.34 percent, and capital stock by 6.1 percent. The increase in other federal government tax revenue would more than offset the revenue decline from the estate tax, and would ultimately result a net revenue increase of $89 billion by 2021.”
2.) As a tax on assets, the death tax reduces incentives for investing and entrepreneurship, and increases the likelihood of businesses being closed or sold.
It is understandable that a death tax on assets of 40 percent – especially after paying a lifetime of other taxes and fees to the government – would serve as a disincentive to business investment, an incentive for selling a business before death, and/or causing descendants to have to sell assets or a business.
Among its key points, it was pointed out in a 2012 Joint Economic Committee report: “The estate tax is an overwhelming cause of the dissolution of family businesses. The estate tax is a significant hindrance to entrepreneurial activity because many family businesses lack sufficient liquid assets to pay estate tax liabilities.”
And as Curtis Buday noted in a 2010 Heritage Foundation report:
“The death tax stands in the way of entrepreneurs. When a person weighs the risk of a new business venture, he takes into account all the costs he will face in order to deter- mine the final return he will earn. He then weighs whether the return he could earn is worth the risk of losing all he invests in the enterprise. The death tax raises the costs an entrepreneur will pay because it promises to confiscate a portion of his business upon his death…
“Estates that consist largely of family-owned businesses are the most vulnerable to the death tax. Family-owned businesses and the families that own and operate them are synonymous for purposes of the death tax. The value of the portion of a business owned by a deceased person, including the business’s assets, such as equipment and property, is included in their estate. The high value of these assets is the cause of the problem for family-owned businesses.”
In addition to the study by Stephen Entin noted above, other analyses make clear this impact on small and family businesses. For example, a 2010 study by Douglas Holtz-Eakin and Cameron T. Smith reported: “This paper examines the impacts of a higher estate tax rate on asset accumulation, small and family businesses’ cost of capital, investment outlays, desire to hire, size of payrolls and jobs. In each instance, raising the estate tax has significant negative impacts.”
And as for the implications for entrepreneurship, the Tax Foundation has reported:
“Previous Tax Foundation research has shown the estate tax hurts the economy by discouraging entrepreneurship. A 1994 study found that the estate tax’s 55 percent rate at the time had roughly the same disincentive effect as doubling an entrepreneur’s top effective marginal income tax rate. Thus, because of the estate tax an entrepreneur facing a 31 percent statutory income tax rate would behave as if he or she were facing an effective 62 percent income tax rate.
“As the effective tax rates facing entrepreneurs rise, each hour of extra work is worth less in terms of after-tax income. Under reasonable economic assumptions, at some point the threat of estate taxation causes entrepreneurs to become more likely to retire early rather than continue to work. If the estate tax encourages entrepreneurs to stop working and saving, not only does this reduce federal income and payroll tax revenue, but also results in less overall wealth creation in the U.S. economy.”
3.) The economic costs of the death tax are broad, diverse and substantial.
There are many costs inflicted upon the economy thanks to the death tax, including, as noted, reduced incentives for risk taking; and considerable resources lost on tax planning and avoidance measures, such as on accountants, lawyers and even life insurance to pay estate taxes.
As summed up in the 2012 Joint Economic Committee report: “The large number of tax avoidance options permitted under the estate tax means that the tax will result in a tax burden distributed unfairly among payers of the tax, will be unnecessarily complicated, and will significantly distort taxpayer behavior.”
4.) Death taxes are grossly unfair.
Think about all of the taxes paid over an entire lifetime – personal income taxes, corporate income taxes, payroll taxes, capital gains taxes, property taxes, personal property taxes, sales taxes, excise taxes, tariffs, gross receipts taxes, government fees, and the list goes on and on. After such a taxing life, it is clearly not fair for the government to step up at death and lay another whopping tax on assets.
5.) Envy and class warfare always make for bad economics.
In reality, the death tax winds up being little more than a “get the rich” political impulse. That is, the death tax is rooted in envy and class warfare. Indeed, some argue that the death tax should be retained, but applied only to certain large estates, perhaps excluding farms and family businesses.
But a key question must be asked: Where are resources going to be used more efficiently – in the hands of investors and business owners in the private sector, or in the hands of politicians and government bureaucrats? Keep in mind that the “rich” are those with the resources to invest in new ideas, inventions, innovations and/or start-ups. Others might simply invest in more established businesses through equity or debt markets, thereby providing liquid capital markets where firms can raise funds to expand or improve efficiency. All of these activities are clear economic positives.
In contrast, the incentives in government are political, not economic. Without prices, profits, losses, competition, and private ownership to guide resource allocation, waste runs rampant in government. Draining resources from the private sector in order to be doled out according to politics is an economic negative.
Benefits from Ending the Death Tax
A June 2016 Tax Foundation study examined the effects of death tax proposals from presidential candidates. It was explained: “The primary effect of the estate tax under a dynamic model is that production is reallocated away from goods that fall under the estate tax base to goods that do not… This is true of many kinds of taxes, but it is particularly harmful in the case of the estate tax. Many of the assets that fall under the estate tax, such as residential structures, commercial structures, and business equipment, enhance productivity, or gross domestic product (GDP) per hour worked.”
Looking at Donald Trump’s proposal to eliminate the death tax, key findings were:
● Increased investment, higher productivity and more jobs. “Elimination of the estate tax would cause a reallocation of economic production from consumption goods to capital goods, relative to current levels. On the whole, the equilibrium level of capital investment in the economy would be 2.3 percent higher, which would boost productivity by 0.7 percent. As a result of the higher productivity, workers would be incentivized to work somewhat longer hours, increasing labor force participation by the equivalent of 159,000 full-time jobs.”
● Minimal federal revenue losses. “Eliminating the estate tax would decrease federal revenue by $240 billion over 10 years. However, the macroeconomic impact of the estate tax elimination would include increased wages and incomes, which would increase the receipts from other taxes. After taking this into account, the total revenue loss from estate tax elimination would be only $19 billion total over 10 years.”
● Higher incomes. “Eliminating the estate tax would increase after-tax incomes for those taxpayers who receive assets from a taxable estate. After macroeconomic impacts of a larger capital stock are considered, it would increase after-tax incomes for all taxpayers.”
In the end, the small business and economic case for eliminating the death tax via tax reform is clear and not in any substantive dispute.
Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.
Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP: The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.