The History and Future of the Estate Tax
By (popular) demand (very exciting for my second day!) here's a little Estate Tax 101.
Simply put, the estate tax is a tax on property owned by a decedent at death. The tax has been controversial in the last decade or so. In 2000, Congress passed a bill repealing the estate tax, which President Clinton vetoed. Then Congress tossed in a sunset provision, and as a result a temporary repeal was enacted in 2001 (any subsequent attempts to pass a permanent bill have been blocked in the Senate).
The law works like this: from 2001 to 2010, the exclusion amount (the amount up to which there is no estate tax) will increase, and the estate tax rates will decrease; then, the estate tax will be “repealed” in 2010 for the year, and then kick back in at the original rates in 2011. IRS sec. 2001. (This provision has always puzzled me because of the incentives it creates … Would it be so surprising if the number of fatal “accidents” involving extremely wealthy old people miraculously increased in 2010?).
The estate was first created to help fund WWI. Besides the revenue need (collected from those who can afford it), the justification for the tax is redistributive. Congress wanted to prevent the rise of a “leisure class” that would control most of the wealth without having to work, hence the estate tax is meant to achieve equality of resources (making wealth a function of work, rather than status).
Besides property owned at death, the estate tax also encompasses property given away during life in which the decedent had retained certain interests. (The IRS has really complex rules for this). The rates have changed over the years - starting at 10% and growing to 70% in 1935. (It's somewhere around 45% now - not quite sure where we are on the phasedown).
The tax only applies to a small percentage of the extremely wealthy (some studies suggest about .5% of the population). The short reach is because of the size of the exclusion; most people’s estates don’t come anywhere near this amount. And as always, there a lot of ways to avoid a substantial portion of the estate tax (for instance making tax-free inter-vivos gifts).
It is interesting that the estate tax tends to be regressive in the group that it applies to. Because of the exemption after a certain point, the estate tax burden (percentage of the estate paid as tax) begins to fall as the size of the estate increases.
One of the practical arguments often made for the estate tax is that it ensures that the wealthy are being taxed on capital gains. When appreciated capital assets are left to heirs, under current law they get a basis step up. So because the capital gains are never realized, they are never caught by the income tax. The estate tax, however, taxes the transfer. IRS 1014 and 1022. Many have argued for a repeal of the estate tax coupled with the elimination of the basis step up, which could be a revenue wash and simplification of the system, but even this proposal could have perverse effects and enforcement complications.
The typical argument in favor of repeal of the estate tax are: 1) the tax raises little revenue, not justifying the administrative costs (the funny thing about this is that the argument partially relies on the fact that the rich are better at avoiding taxes - better enforcement and less loopholes would fix this, as would the expansion of the tax); 2) the “death tax” is unfair; 3) the distributive effects of the tax are minimal, and relatedly, the estate tax affects the heirs but takes only the richer owners' financial situation into account.
A economic argument against the tax is that it creates economic inefficiencies by discouraging wealth-creating activities, slowing economic growth. This last argument is a variant of a standard observation in economic taxation literature: taxes in general have distortion effects because they reduce the value of work.
It has been argued that in the case of the estate tax, the distortion creates particularly perverse effects. If the estate tax reduces the capital stock in the economy (because supply is lower), rates of return on capital will go up, and since the rich own most of the capital, they actually get richer as a side-effect.
Any thoughts? Not sure how strong the lobbying effort is on this issue ... Predictions?
Here’s a fun blog discussion on these issues. For a more academic flavor, try the Will, Trust & Estates Prof Blog.
May 5, 2007 2:29 PM | Reply | Permalink
Kevin:
I don't even think the tax begins until several million dollars in assets. How would that affect the middle class heirs?
Satellite Sky Blog
Find the Truth. Do Justice.
May 5, 2007 9:17 PM | Reply | Permalink
I wasn't referring to the estate tax itself, but rather to the basis step-up under Section 1014 of the Tax Code. The step-up generally applies to every decedent's transfer of property with untaxed accrued gains -- regardless of the income of the decedent or the recipient. A decedent who doesn't even come close to qualifying for the estate tax might still (and often do) have assets that fall under the basis step-up rule of Section 1014.
For example, imagine that my father has assets that in the aggregate are valued at only $50,000. One of those assets is shares of a stock that originally cost him $100. Now imagine that he never sold that stock but instead has held it for many years while it appreciated in value so that today it is worth $10,000 FMV. If he were to gift it to me tomorrow (while alive), when I eventually sold it I would be taxed on the $9,900 in capital gains that accrued while he held it. That's because I take his carry-over basis in the stock.
If, however, he died and the stock passed to me as his beneficiary, I would receive it (pursuant to Section 1014) under a stepped-up basis, which essentially means the $9,900 in accrued capital gains would be erased. My basis in the stock becomes the FMV at the time of transfer ($10,000), so when I sell it I would only pay taxes for gains beyond the original $9,900. Assuming a 15% tax on long-term capital gains, this scenario under Section 1014 would result in a real tax savings to me of 15% of $9,900 -- a $1,485 savings.
You can see, then, why Section 1014 is beneficial across-the-board, but particularly for middle class families. Conisder first the polar ends of the wealth divide. Families of lower means don't tend to have significant assets with appreciated but unrealized value to transfer on death. Wealthy families on the other hand will usually have such assets, but they also have access during life to very talented estate planners who could work around tax liabilities and help shield assets if the Section 1014 rule were eliminated.
The bulk of the impact would therefore seemingly hit middle class families who typically hold at least modest amounts of appreciated assets at the time of death. Although not subject to the estate tax, these heirs would face large tax bills upon realizing any of the decedent's appreciated gains should Section 1014's basis step-up rule be eliminated. In this sense, repeal of Section 1014 would be the equivalent of a death tax for all income levels.
Granted, Tijana will probably point out that we are sometimes overly averse to termination of a tax benefit (like 1014) because of the rhetorical force of such changes. Ending a benefit looks like a tax increase but is in fact merely a regression to the mean. But once something like Section 1014 becomes entrenched the endowment effect kicks in and baselines are readjusted.
Maybe I'm a hypocrite, because the same could be said about Bush's tax cuts -- they've become the new baseline, so repealing them will look like tax increases -- but I'm all for repealing those tax cuts.
Regardless, though, my intuition (and keep in mind that I'm no tax expert) is that Section 1014 overlaps with other tax rules enough that experts could help rich families avoid feeling the sting of losing the benefits of a basis step-up. For the rest of us who rely on Section 1014 but don't have that knowledge or access to estate planning, losing it would be quite damaging.
One additional note: Section 1014 sunsets after 2009, but it's scheduled to be replaced with 26 U.S.C. 1022. Section 1022 is a bit more complex, but it essentially restricts the basis step-up described above to $1.3 million in assets. Anyone possessing assets above that amount that would previously have received a stepped up basis upon transfer by death will only get the benefit of the rule for the first $1.3 million in assets. I don't have any problem with Section 1022, because it certainly doesn't impact middle or lower class families. I will, however, keep my eye on the issue and see if a general repeal of Sections 1014/1022 (eliminating the basis step up for all assets) is put on the table. That's where I'll start to get worried.
May 5, 2007 10:33 PM | Reply | Permalink
What I've always liked about the estate tax is it's anti-dynastic effect. Without the estate tax, very wealthy families will have the opportunity to extend the capital generated in one generation to several generations of heirs. With interest and investment income, several generations of Hiltons and Buffets and Waltons could live without any sort of labor and minimal taxation. This isn't necessarily immoral, but it's bad for democracy and bad for government. We're already seeing fabricated grassroots lobbying groups directed by a handful of very wealthy families. The Supreme Court has decided that money and speech are equal and equally protected, giving more political power to wealthier citizens.
The framework of laws, customs and people which allowed enormous wealth to be generated in the first place costs money to sustain. To make it possible for future generations to create their own wealth, that framework must be funded and carefully managed in the interests of society as a whole. By allowing a permanent leisure class, we create greater divisions of power and interest. Without an estate tax, the very wealthy will have more ways to retain their wealth, and a greater incentive to do so. At the same time, incentives toward charitable giving will diminish when there is no estate tax to avoid. So non-government organizations which were performing a socially useful function (the reason for their tax exemption), will lose a major source of funding. Government also loses funding, limiting the resources available to less-than-very-wealthy citizens.
The estate tax is an essential barrier to dynasties of wealth and privilege. Do we really want to enable a permanent American aristocracy?
May 6, 2007 1:49 AM | Reply | Permalink
Welcome. Refreshingly substantive post. Thanks OkieLawyer for prompting this discussion in the last post. Interesting step-up background from klovecchio.
The temporary repeal provision "could" be an effort by the dynastic rich to increase the constituency behind a permanent abolition of the tax by activating the newer-money margins of the repeal-beneficiaries. Especially the new rich who, while hit by estate taxes, are not old money dynasties yet. They may not be tuned into the generational checks on their wealth-power-descent that the estate tax represents, if even that means clever lawyers' fees plus occasional liabilities. Some among boomers and others may be ambivalent about dynasties anyhow -- Warren Buffet for example.
How would it work? First, by removing many of the lower-end asset holders in the taxed class from the tax burden by upping the asset exclusion figure for long enough that they may question why they still need to pay estate planners for that complicated planning service for yet another contingent unpredictability (dying or not dying during the temporary repeal period). That alone would accentuate the sense of paying lawyers for intangibles. (Remember, the dynastic rich do not necessarily like lawyers. Lawyers were necessary technicians in old England, not necessarily of the elite, and America's dynasties are not completely off of that tradition.) Meanwhile, as the new-rich feel discomfited, the richest of the repeal-beneficiaries would enjoy reduced rates for ten years, none for one, and those among the dynasties who are behind the lobbying effort for repeal who may have been certain of who among them would die (or hire Dr. Kevorkian's colleagues) within that period might have advised their devisees, donees and the like to use the windfall to rally the new-money constituencies behind permanent abolition.
If the dynastics were really crafty, and wanted to fit into this tax-law conspiracy theory, they would have also released a great deal of capital cash flow into the economy during the eleven year period to demonstrate that the resulting growth came from their anticipation of savings from temporary repeals, i.e. we are really good folks and don't need a tax to make us give back to our country, or the world. Well, we're like Mr. Buffet. Sort of.
And the funny thing is, much as some would like to believe otherwise, some of these super-rich are more generous even to scale than some folks with much less. Fear of loss can hit any of us, any time, and cause sometimes illogical results.
Sounds like a plot! The theme: we can't take it with us, and neither can our devisees, legacy-takers or donees. What, really, do you have at the end? What really, is important to save up now?
Honor: Ilsa's and Rick's decisions in Casablanca.
May 6, 2007 2:13 AM | Reply | Permalink
Welcome to the Cafe -- and thanks for the immediate response to us lowly denizens. (Not that OkieLawyer is "lowly," but it's delightful to have a "named" blogger responding so promptly.)
Repealing the estate tax probably seems like a good idea to most Americans. No matter what the statistics say, we all hope -- or even expect -- that one day, that tax will apply to us. It's the American Dream. ;) After all, when 80% of drivers think that they are "above average," it's not that difficult to see that such an attitude is likely to transfer.
Policy-wise, the estate tax seems to make sense. But there's something visceral that doesn't sit quite right for me. Don't all Americans have the right to bestow their goods as they wish? Why should the wealthy be stripped of that right?May 6, 2007 3:31 AM | Reply | Permalink
The Republicans love to refer to the estate tax as the death tax as if they think the dead know they are being taxed and are capable of resenting it. In reality it is a tax on unearned income resulting from being an heir by birth or bequest. While I think parents ought to be able to leave their children enough to have a home or keep and operate a small family buisness say, three to five million, and as I share Oscar Wilde's opinion of the unspeakable in pursuit of the uneatable (a leisure class) I do not want to see accumulating fortunes passed down to people who did not earn them.
If we do away with the estate tax we might as well pass an act reinstating a royal class because the effect will be the same with out the hereditary titles. My hero from the Robber Baron and Gilded Age was Andrew Carnage. If one doesn’t know why he was exceptional they should find out.
I believe in, after a reasonable limit, taxing the hell out of unearned income, doing away with tax free foundations that were devised avoid taxes and to pass on control of fortunes, then taxing the living a lot less as a result. Put it back in the pot for the living and hard working citizens to have a shot at acquiring. For me economic opportunity is the name of the game and you cannot have that if wealth accumulates in the top three to five percent of the population. Of course if one prefers the Republican tax policy and mentality then at some future but certain date economic opportunity will be achieved in bloody revolution by the an impoverished ninety-five percent that eliminates the five percent of the haves. I prefer peaceful democratic solutions to obvious problems of cupidity running wild much better than bloody revolution.
May 6, 2007 5:05 AM | Reply | Permalink
This says more about the unsophistication of the American people than it does the value of the Estate tax. Framed the way the Republicans (Frank Luntz?) frame it, its no wonder many people want to repeal it, after all they do "Support the troops" don't they?
Under current law, the basic exemption from the estate tax is $2 million (although one spouse typically can leave everything to the other spouse, tax-free). The exemption is scheduled to remain at $2 million in 2007 and 2008 and rise to $3.5 million in 2009. The estate tax is set to disappear entirely in 2010 -- only to come back again in 2011 with a $1 million exemption. The top tax rate today is 46%.
The estate tax affected only 12,600 families with more than $2 million in assets last year, a number that will decline to 7,200 by 2009, according to a study by the Tax Policy Center.
This is a delusion when you consider globalization and the way our redistribution of wealth has been trending.
May 6, 2007 5:25 AM | Reply | Permalink
Surely there is an optimal rate which is the best balance between any positives and negatives generated by the tax. But I see no logical or moral argument that succeeds in making it an unalloyed bad idea.
I do see both logical and moral arguments in favor of limiting the persistence of dynasties.
May 6, 2007 6:05 AM | Reply | Permalink
This happens to be one of my hobby horses. It is a perfect example of how libertarian ideas get promoted by those with a stake in the outcome. What I would like to highlight is the mechanism of how a topic like this gets into the public sphere and how public opinion gets influenced.
As has been pointed out above, the estate tax affects very few people, but those that it does affect have a big stake in changing the laws. The Walton family (owners of Walmart) stand to save $40 billion if the tax is repealed. It turns out that what seems to those who haven't been paying close attention a spontaneous interest in the topic is actually a well planned campaign for change.
Just 18 super wealthy families have been behind the decade long effort to repeal the estate tax. They have done their best to keep their fingerprints off the evidence. Their technique has been to fund right wing and libertarian think tanks which then provide the intellectual cover for their selfish agenda. They also make selective contributions to the campaigns of politicians who support their goals. There is nothing grass roots about this effort.
For those who want to read the details of how this propaganda campaign has been managed here is a report:
Spending Millions to Save Billions (PDF)
The left tends to look on social topics as intellectual exercises and expect that logic and data will win out. The right uses raw power and political influence to achieve its aims. The intellectual cover that they buy is just a smoke screen.
This topic is a good example of the general way things are managed, especially since the source of the funding has been (mostly) uncovered. The same techniques are used in many other areas, the one in the news these days is global climate change. Notice that it took quite awhile to reveal that Exxon was behind several of the most vocal global warming deniers.
--- Policies not Politics
Daily Landscape
May 6, 2007 6:34 AM | Reply | Permalink
Why should you expect to get the $10,000 stock tax free? If your employer were to give you the $10,000 in stock, you'd pay income taxes on the $10,000 and then capital gains taxes on any future increase in value. The tax treatment you're advocating for creates a real inequity between those who inherit their wealth and those who work to earn it. Under the system you are recommending, if you inherit $10,000 in stock, you pay no taxes (except for the eventual capital gain, if any). If I work and earn $10,000 in stock, I pay income taxes on the $10,000, plus capital gains taxes on any increase in value. The treatment you are arguing for biases the tax system in favor of those who inherit stock rather than earn it.
May 6, 2007 6:34 AM | Reply | Permalink
Viviane,you are probably right about how most Americans feel, but this is because they misunderstand the complex tax issue. Here's an example. Let's say I invest $100,000 in a start-up company when I'm forty. The company does well and when I die at 85, the stock I purchased for $100,000 forty-five years ago is now worth $100 million. Without any kind of estate or inheritance tax, I can pass that $100 million to my children. No one--not me, not them--pays any taxes on the gain of $99.9 million. I don't think anyone thinks it's fair if Paris Hilton can get $100 million from her daddy without her or her daddy ever paying any taxes on it, while most Americans grinding away for $40,000 a year pay a fifth of their wages to the federal government. The current estate tax arrangement does have problems, I think, but eliminating all taxes on cross-generational transfers creates a great inequity in which the heirs of the wealthiest Americans can live very comfortably while paying relatively little in taxes.
May 6, 2007 7:05 AM | Reply | Permalink
Ms Dvornic comments
Really ? If you used to pay the rent by digging 1 hole and higher taxes means you now have to dig 10 , you've been motivated to dig more holes , so work's value hasn't been reduced it's been enhanced .
Sure at a 99% tax rate work ceases to have value but that's an extreme and extremes aren't useful in constructing a general law .
In the real world , differences of degree control. When I swim 100 yards into the ocean , it's recreation. If I swam 1000 yards , I'd drown . That doesn't mean it's dangerous for me to swim 100 yards. Not even 10% dangerous .
Ditto with tax rates.
May 6, 2007 8:26 AM | Reply | Permalink
Consider the firm owner. If she has something to sell that brings in a net per-unit profit, she is going to want to sell as many of them as she possibly can, period. That means her per-unit costs are lower than her per-unit profits. The only time when it begins to matter is when prices drop to a level where the net return becomes lower than the next best income-earning alternative that the firm owner/manager might have. Of course, if all income earners are taxed at progressive rates, the next best alternatives will tend to be no more attractive than the originally preferred alternative.
In almost any instance one can imagine, bringing in a smaller after-tax return on your investment due to taxation actually provides income earners with a greater incentive to work harder, longer hours, etc., not a reduced incentive. It's true that they may not like having to settle for a reduced disposable income, but that is not equivalent in meaning to saying that they will gladly work less and settle for an even smaller disposable income in protest against the fact that they will now have to work harder/more to obtain the same amount of disposable income they brought in previously.
The bottom line: if they want to end up with a certain amount of money after taxes, then they will have to consider working more. That's something we've seen more and more of in this economy as individual income earners have struggled to get by...they work a second job to try to stay above water.
If you get a big windfall from a tax cut, it provides many (perhaps most?) people with an incentive to work less; with a bigger per-time-unit payoff from work, many will find themselves better able to afford more leisure. That, my friends, is a disincentive to work harder, not an incentive.
The incentive argument is just one more component of the Republican Party's economic mythology that has gained currency for no other reason than it has been repeated so many times, many get the impression that it must have some substance, even though it does not. What is amazing is how many educated people actually fall for their obfuscation and misrepresentation of the truth.
May 6, 2007 8:29 AM | Reply | Permalink
After excluding certain low income/poor people, I never heard a convincing argument for why capital gains, dividends and interest shouldn't be taxed the same way earned income is taxed.
May 6, 2007 8:51 AM | Reply | Permalink
It seems that the cost basis step up is the only fair thing here that shouldn't be changed.
If I inherit stock worth $10K that cost $100 to the person with the will, I shouldn't be taxed on $9,900 in gains. I received something worth $10K and should only be taxed on gains over $10K.
Now, one can argue that nobody ever paid taxes on $9,900 in gains but nobody ever realized those gains, either. Why tax an unrealized gain?
Dropping the step-up in order to fund a repeal of the estate tax is lunacy. Keep the estate tax, maybe increase it, and keep the step-up.
thosethingswesay.blogspot.com
May 6, 2007 8:51 AM | Reply | Permalink
dest,
Sure you realized the gains, when that $100.00 investment wound up in your hands as $10,000 in purchasing power.
Can you not use the $9,900 gain to purchase more stock? Should you then only be taxed on the capital gain of the new stock?
May 6, 2007 8:59 AM | Reply | Permalink
You make a really excellent point. There hasn't been a single time in my working life where I have turned down an overtime shift or a freelance project or a shot at a bonus because the tax rates don't make it worth my while.
Sure, like everybody I sometimes look at my pay stub and think, "If I could just have all of the money withheld for 3 months I'd be out of debt," or "Could buy a car," or "Could save for a down payment on a house," but it doesn't stop me from working...
thosethingswesay.blogspot.com
May 6, 2007 9:00 AM | Reply | Permalink
Destor, why should you be able to receive something worth $10,000 tax free? If you earned that stock from your employer, you'd pay income taxes on its value when you received it, plus capital gains taxes on any gain you realized above the original value when you sold the stock. Just because someone gave you your shares doesn't seem to be a reason to exempt the shares from taxes. Even without the step-up, you're getting a great deal compared to someone who earned the stock as pay from their employer. This is for three reasons:
First you inherit the original shareholder's cost basis, so you only owe taxes on $9,900 rather than the full $10,000 your gift is worth.
Second, you pay capital gains rates on the $9,900 rather than income tax rates. (If I earned the stock as pay, I'd pay higher income tax rates on the full $10,000 value.)
Third, you don't have to pay taxes until you sell the shares. (If I earned the stock as pay, I'd have to pay my income taxes in the year the stock was received, then capital gains taxes in the year I sold the shares.)
With a step up, you are paying taxes (at capital gains rates) only on any value above the $10,000 orginal value. This is an even better deal, but you get that deal only because theoretically your benefactor already covered the taxes on the $10,000 by paying the estate tax.
May 6, 2007 9:09 AM | Reply | Permalink
I expected this response, and to some extent I agree with it. But the same can be said about an enormous amount of tax policy. The mortgage interest deduction, exemption for primary home sales, and other provisions are biased in favor of homeownership. The student loan interest deduction is a bias in favor of student loans versus other loans. And on, and on...
But for all the reasons I mentioned above, the basis step-up is something that I support. Maybe I'll change my mind during the next administration, when my tax dollars are being spent (hopefully) by a better administration, but for now I'll stick to this opinion.
May 6, 2007 9:13 AM | Reply | Permalink
<DELETE>
May 6, 2007 9:14 AM | Reply | Permalink
Remember, you don't pay any taxes until you actually sell the shares. So you can inherit the $10,000 without any immediate tax cost. It's only when you sell that you pay taxes. If the shares are worth $11,000 when you sell, you'd pay capital gains taxes on $1,000 with the step-up and on $10,900 without the step up. The first approach gives you a tremendous amount of value for very little tax cost (at a 15% capital gains rate, you'd pay $150 on an $11,000 increase in your wealth--an effective tax rate of 1.4%). The second still gives you pretty good value because you are paying low capital gains rates on less than the full value of the shares (you'd pay $1,635 on the $11,000 increase in wealth, an effective tax rate of 14.9%).
May 6, 2007 9:18 AM | Reply | Permalink
Hey Purple and John,
Excellent discussion.
I'd argue this... in this scenario, no gain is ever realized at a $100 basis. The guy who gave the stock away is dead. So it's just an asset.
Now, if you want to tax the transfer of the asset at some sort of estate level, I'm fine with that.
Alternately, you could argue that my cost basis is either zero or that it's $10,000.
I guess I'm just more inclined to keep the step-up and the estate tax than I am to eliminate the estate tax and then eliminate the step-up in order to pay for it.
I think middle class people are more likely to benefit form the step-up than they are to encounter the straight-up estate tax.
thosethingswesay.blogspot.com
May 6, 2007 9:28 AM | Reply | Permalink
The estate tax and step up together are fair, since you are assuming that taxes were paid when the estate was settled. Eliminating the estate tax and keeping the step up creates a windfall for those with large amounts of capital to transfer. So if you eliminate the estate tax, you almost certainly have to also eliminate the step up. Personally, I like keeping the estate tax, although I do think it has some negative consequences for people who hold undeveloped land, farms, or small businesses (which may be valued at several million dollars even though the income generated from these assets is modest). I'd like to see some way to help the small number of middle class people who have to liquidate property to cover estate taxes.
May 6, 2007 9:47 AM | Reply | Permalink
Just like to point out that the temporary nature of this portion of the Economic Growth and Tax Relief Reconciliation Act of 2001 is due to the fact that it is not revenue neutral - it loses revenue. The entire bill may be revenue neutral or revenue enhancing, but those provisions which cannot display revenue enhancement must have a sunset provision.
If you have the time & inclination go read "Myths About the Estate Tax: Rhetoric versus Reality" by the Democratic staff of the Joint Economic Committee at
http://jec.senate.gov/Documents/Reports/estatetax.pdf
May 6, 2007 10:17 AM | Reply | Permalink
First of all, a hearty welcome;
In response to your introducing yourself to us, OkieLawyer said
Your response to those questions in today's essay,
is on the mark, but I'd like to amplify on it just a little. As far as I know, the idea first received wide distribution in the United States from a most peculiar source, the Robber Baron and Philanthropist Andrew Carnegie. Way back in 1889 he wrote a tract called The Gospel of Wealth.
Carnegie argued against the bestowing of large estates upon the children of the wealthy primarily on two grounds. First, it was harmful to those who received the inheritances (I wonder if we'd call this the Paris Hilton effect today?):
Carnegie said:
Second, he argued that largely taxing inheritances away was beneficial to the state and community as well:
There's a lot not to admire about Carnegie, but in managing his wealth he practiced what he preached, and were he alive today, he'd probably be leading the charge to restore the inheritance tax. I don't think, looking at today's America, he'd find much reason to change his mind. The screed is short, and requires some tolerance of Victorian language, but it is worth reading in whole.
Our own era's Carnegie, Bill Gates, seems to agree with the Victorian proponent of inheritance taxes, or at least he did when Bill Moyers interviewed him in January, 2003,
aMike
May 6, 2007 10:29 AM | Reply | Permalink
You can make a good argument for indexing capital gains to inflation, but otherwise I agree with you.
May 6, 2007 10:52 AM | Reply | Permalink
Andrew Carnegie once observed there were two great sins in life, to be born poor and to die rich.
May 6, 2007 11:15 AM | Reply | Permalink
If the Estate Tax.....oops, Death Tax, is as harmful and unfair as the Republicans on the national level say it is, then why is it seen differently to State Level Republicans.
Under Repub Gov. Tom Ridge and the Repub House and Senate in PA. we have an Estate Tax, damn! there I go again, I mean a Death Tax:
There is no exemption similar to the Federal exemption of the first $2 million per spouse, the entire estate is taxed, minus debts, legal fees. etc. (This means 'all'* estates are taxed, not just those in the top 1%.)
The tax rates are;
*Spousal tax Zero
Lineal Descendents such as children, grandchildren and step children 4.5%
Siblings 12%
Nieces, nephews 15%
Under Republican rule, if you live in Pennsylvania and your estate totals $35,000.......its taxed!
May 6, 2007 11:28 AM | Reply | Permalink
Capital gain tax rates do make a difference when you're deciding whether to move money from one capital investment to another. The higher the capital gains rate, the more the new investment has to pay in order for the transfer to be worthwhile within your investment time horizon. While this effect is real and is sometimes used as an argument for keeping capital gains tax rates low, I'm not sure whether the magnitude of the effect is all that significant. The other argument, of course, is that capital gains taxes tend to remove money from private investment. This may be true, but I'm not sure the effect on the economy is as significant as the advocates of low capital gains rates claim. Not all private investment is good investment after all, and not all government expenditures are bad for the economy--in fact, some are essential to keep the economy healthy.
May 6, 2007 11:50 AM | Reply | Permalink
PurpleState, disregard the estate tax for the moment. I'm curious what you think of the step-up phase out included in Section 1022 (at $1.3 million). I have the same dynastic concerns as you, but I see the value in the step-up for middle-income families. What about a new phase-out that preserves the basis step-up but for a lower aggregate amount of assets? Let's say something like $50,000 of basis step-up, with the remainder being subject to a carryover basis?
May 6, 2007 11:54 AM | Reply | Permalink
Here's what I don't get, Purple... the people who want to eliminate the estate tax and who use the "family farm," argument never seem to deal with the idea keeping the estate tax and adding a farm/homestead exemption, something that would keep moderate sized family businesses out of the equation.
I agree with you that the family farm element of this is troubling but can't the law just be ammended without having the whole tax thrown out? Why do the family farm and the Hilton family hotels need to be treated the same way?
I rather doubt that too many family farms are lost to estate taxes but if any are, exempt them. That's pretty easy.
thosethingswesay.blogspot.com
May 6, 2007 11:55 AM | Reply | Permalink
Destor, I think the exemption idea would work fine--or maybe some way of defering taxes until the farm is liquidated (if the heirs ever decide to do that).
I agree that the family farm objection to the estate tax is normally raised as a rhetorical move by people who really are just opposed to the estate tax (and probably all taxes) in general. And I doubt that too many farms are affected each year. However, I do know middle class people who have been affected because (in one case) their relative owned a bunch of undeveloped waterfront property that had been in the family for generations. Well now that property is in a popular resort area and it's valued at $4 or $5 million. The family doesn't have the money to pay estate taxes on that inheritance, so they are looking at selling some of the land to developers. This means a pristine forest will be converted to condos. They are looking for alternatives--they may donate the land to a conservation organization or give it to the state--but they certainly can't keep the land themselves and leave it undeveloped. The estate tax won't let them do that. I'm not sure this is a tragedy--particularly if they do decide to just give the land to the state or a conservation organization--but nine out of ten times in situations like this, the family will sell to developers. That's unfortunate in my mind, since undeveloped land (or farm land) is increasingly endangered. I hate to see tax policy encouraging more sprawl.
May 6, 2007 12:31 PM | Reply | Permalink
I completely agree with you that there are adverse consequences to the current law. I'd also worry that, in your example, the middle class family not only has to sell to developers but has to sell on unfavorable terms as having a tax bill due puts the seller's back against the wall.
I wonder why we can't means test our way out of that scenario, though? Your middle class family, or a family farm, would be able to prove to the IRS that the taxes incurred give them no choice but to sell. If there's no choice but to sell, they should be exempt from the tax. The Hilton family wouldn't be in the same boat as they'd have the means to pay the tax while passing on an operating business to heirs.
The anti estate taxers are so rhetorically effective because, no matter how seldom it happens the "lose your farm or property to pay the tax," scenario is deeply unfair whenever it does occur.
thosethingswesay.blogspot.com
May 6, 2007 12:37 PM | Reply | Permalink
There are no recorded examples of the "family farm" being lost due to estate taxes. There are very simple things that can be done to deal with the few farms which are worth enough that they might have to deal with this situation. Ask any competent tax accountant if you need advice.
I guess from the comments going back and forth that very few have taken the time to read the report I cited in my prior comment. To cut to the chase - all the libertarian and sob stories offered by the paid pundit class are bunk.
Don't argue hypotheticals, look up whose ox gets gored. The bottom line is that if the wealthy avoid pay tax (estate, capital gains or other types) the alternative is that everyone else pays more, or that the deficit increases, or that social services are cut back. The wealthy have little need for communal social services, they can pay for their own retirement and health care. They even pay for their children's education in private schools, so why should the support taxes that benefit others?
Finally the argument that high taxes inhibits entrepreneurship in the wealthy is also false. The majority of the wealthy these day inherited their fortunes. The self made men like Bill Gates weren't motivated by money, they were motivated by the desire to succeed or best the competition or other motives.
Those who are fighting the hardest to preserve intergenerational wealth are the heirs, not the founders. Two words - Paris Hilton.
--- Policies not Politics
Daily Landscape
May 6, 2007 12:48 PM | Reply | Permalink
klovecchio, I think it's hard to evaluate the phase-out of the step-up without considering the estate tax. With an estate tax, the step-up makes sense (and shouldn't be phased out), because the taxes on the inheritance are covered when the estate is settled and the estate tax is paid. Without an estate tax, however, the step up essentially allows for the tax-free transfer of appreciated assets. I don't mind an exemption to allow a parent to leave a house or a modest amount of capital to a child--maybe even the $1.3 million exemption is okay, given the value of homes and land nowadays. This essentially would have the same effect as the current estate-tax deduction. Beyond that, however, I think the step-up makes no sense if the estate tax is phased out.
All that said, though, I'm not sure the current estate tax is a well-designed tax. I'll try to explain why in a separate post. I support the taxation of cross-generational transfers strongly--but I'm not sure the current system is great.
May 6, 2007 12:48 PM | Reply | Permalink
Welcome to the Cafe
One of the problems with he estate tax repeal arguments is that they treat the estate tax in isolation. It is explicitly part of the gift tax system. These taxes are in turn meant to work in conjunction with the income tax.
There are so many tax planning techniques, haven't Republicans ever talked to an accountant, to virtually avoid any taxes I never understand the issue other than it makes Steve Forbes all excited.
Nelson Rockefeller used his will to give away millions of dollars worth of art to MOMA for which his estate received a huge credit. Jackie Kennedy set up a charitable lead trust in her will. She froze the size of her estate, provided millions in charity for over two decades and will be giving her grandchildren millions tax free, even with the estate tax in existence. The debate for repeal seems far more about ideology for an oligarchy than it does for serious tax policy.
Daniel A. Greenbaum
May 6, 2007 1:52 PM | Reply | Permalink
Economic investments---the kind that actually end up improving the economic welfare of a population---involve purchases of capital goods or other economic resources that are used to either produce more capital goods or more final goods that consumers find desirable. In other words, they either increase output or expand the economy's productive capacity. This happens whenever firms purchase machinery/equipment to improve productive efficiency or when they spend money on the construction of new stores or factories or on the salaries of new employees. However, not all firm expenditures are economic investments (money spent by firms on advertising that either (a) misleads consumers or (b) does nothing to help them with their purchasing decisions).
Financial investments---are purchases or commitments of money that provide the "investor" with an income stream. Saving money is a financial investment because it provides interest income; purchases of assets can be financial investments if they eventually provide a capital gain. Economic investments made by firms are usually also financial investments because they generate income that exceeds their cost. The economic investments made by governments that improve infrastructure or human capital are not financial investments because they do not provide the government with an income stream.
Some financial investments are also economic investments, but many of them are not. The purchase of a piece of land, for example, is a financial investment if it appreciates in value over time, but it is not an economic investment if it just sits there, undeveloped. Purchases of stocks in secondary markets (e.g., NYSE, NASDAQ) are clearly financial investments if the stocks appreciate in value, but they are not economic investments because they involve nothing more than exchanges of titles of ownership of already existing assets. They do not typically put any money into the hands of firm managers that could be used for economic investments. That normally happens only when stocks are first sold to underwriters, prior to an initial public offering.
Republican mythologists have taken advantage of the impreciseness of the word "investment" to craft tax policy proposals that sound as though they are beneficial to the economy, but actually are not. The famous Capital Gains Tax Cut, for example, is frequently promoted as an incentive that would stimulate 'investment.' Unfortunately, the only 'investment' that such a tax cut is likely to stimulate is increased financial investment in stocks and other real assets. One financial investor hands money over to another financial investor for a piece of paper. Very little if any of the money involved in these transactions ends up being spent by firm owners/managers on capital goods that would increase output or the productive capacity of the economy.
Wall Street is fond of conflating the meaning/purpose of the two types of 'investment' because they have been able to claim that the churning of stocks in secondary markets somehow benefits all of us in supremely desirable ways. It's the kind of obfuscation that the Republicans have been practicing with success for quite a while...
The Misunderstood Relationship Between Savings And Investment
May 6, 2007 2:13 PM | Reply | Permalink
I like the proposal of Sidney Carroll and Herbert Inhaber in How Rich Is Too Rich?: Income and Wealth in America of a progressive cumulative gift tax.
Basically, the first $1m in gifts received ... either during the givers life or from their estate ... is tax free, the next $1m taxed at 25%, the next $1m taxed at 50%, the next $1m taxed at 75%, and any amount over that taxed at 100%.
So if the estate is divided in units too small to establish self-perpetuating fortunes, there is no estate tax.
This would have to be adjusted for inflation, say once a decade, but it replace the "death duty" with a tax on free rides to the living.
As a side note, the theory that there is a fixed pool of loanable funds, and that adding to or subtracting from that pool determines real returns in capital markets, was understood to be fallacious in the 1930's. However, it was also understood to lead to policies in which you subsidize the wealth accumulation of the wealthy, so perpetuation of that fallacy is a long establish tradition in certain parts of the economic profession.
May 6, 2007 4:45 PM | Reply | Permalink
The problem with your argument is that estate taxes don't even begin to be assessed until after the exemption of several million dollars.
That would have to be one hell of a big "family farm."
Satellite Sky Blog
Find the Truth. Do Justice.
May 6, 2007 5:34 PM | Reply | Permalink
There is actually an exemption in the new carry over basis rules set to take effect in 2010. I believe that each person has effectively $1.3 million in "step up" to allocate to assets, or $3.5 million for a surviving spouse. So most truly middle class families will not be hit by this issue.
May 6, 2007 5:36 PM | Reply | Permalink
I know, I know, I'm no fun... but at the time, Shrublet was so keen on getting it done, but the problem was that the budget projections after 10 years were so expensive they simply could not find any way to pay for it. Because Senate rules required the bill to pay for itself, the only way to get around the rule was to sunset it after 10 years. But for that Senate arcana, we would have had permanent repeal. That's also the reason why we had the idiocy of the phase in of the exemption increase/rate reduction that has made the life of those of use who are estate planners for a living absolutely, positively miserable.
May 6, 2007 5:40 PM | Reply | Permalink
The thing that the purveyors of the "death tax" garbage don't like to tell us is that there actually already ARE provisions in the estate tax code that give preferential treatment to farms and small businesses. For example, Section 2032A is called special use valuation... if you have land that is being actively farmed, it is valued as farm land, even if it would be worth more per acre if it could be developed. Also, Section 6166 allows certain estates that have concentrations of stock, like family owned businesses, to pay the tax in installments over 10 years at like 2% interest so that the business doesn't have to be forced into liquidation.
And amusingly enough, Section 2057 had a deduction for qualified family owned business interests, which basically excluded certain interests in businesses that were being run by family members. It was limited in value and the rules were really tight, but it was there. What happened to it?
It was repealed as part of the SAME bill that repealed the estate tax. Because they cared SO much for small businesses....
May 6, 2007 5:46 PM | Reply | Permalink
Actually, some of the hugest damage done by the bill that repealed the estate tax had to do with the way that the federal tax interacted with the state death taxes. While its complicated to explain, suffice it to say that as a result of the change in the way that the federal deduction for state death taxes is calculated, it effectively repealed at lot of the state level death taxes. So a lot of states were put in the politically unpalatable situation of having affirmatively pass legislation "decouple" the way they calcualted their state taxes from any reference to the federal estate tax.
And they had to do it. While the federal tax may not be a huge revenue raiser, it is on the state level. The inheritance tax in Indiana is one of the primary sources of revenue for the county governments, so its repeal would be (and has been) a huge political issue here. State and local governements are already under huge revenue pressure; federal legislation effectively repealing, involuntarily, part of their tax code was not happy.
May 6, 2007 5:51 PM | Reply | Permalink
oh, and by the way, just to prove my real tax geekiness.... with that rate structure, Penna probably has an inheritance tax.
An estate tax is a tax levied on the estate of the decedent based on the value of the assets he or she owned on the date of his death. The federal tax is an estate tax.
An inhertiance tax is a tax levied on the heir of property-- thus if you have different rates, its probably an inheritance tax. Indiana acutally has both an inheritance tax and an estate tax.
A death tax actually is a separate type of tax.. I understand it actually happens in some European countries. Its a tax that is imposed not on a transfer of property, but on the act of death. Its generally not related to the value of property, but can be a flat fee.
May 6, 2007 5:56 PM | Reply | Permalink
Re: Its a tax that is imposed not on a transfer of property, but on the act of death.
How is this even possible? There's no possible enforcment mechanism. It's not like you can bring the deceased back to life and stick him in jail if he refuses to pay.
May 6, 2007 6:11 PM | Reply | Permalink
To be fair, inflation matters... "several millions" is still a lot of money these days but for a revenue generating business it would qualify you as "small" at best.
Given that truly big businesses in America measure their sales in billions, I'm all for letting those that measure in less than a hundred million have an exemption from estate taxes.
thosethingswesay.blogspot.com
May 6, 2007 6:40 PM | Reply | Permalink
Well, of course. It's much harder for those making significantly less to part with their money.
Bill Gates is currently worth about $56 billion. If he gave away half or 50% of his wealth, he'd still have $28 billion. With that much, he'd still be one of the richest people on the planet. Say he gave away all but $1 billion, or 98.2% of his wealth. He'd still be richer than the vast majority of the people in the US. And his lifestyle would likely not change at all.
But, let's say you're an average American who makes $43,500 per year and has $30,000 in the bank. You're going to have a hard time paying 10% of your income to charity. 98.2% would be completely unthinkable.
Of course these rich people are more charitable. They can afford to be!
May 6, 2007 6:48 PM | Reply | Permalink
Let's ask a slightly different question. Don't all Americans have the right to their paychecks without income taxes being taken out? Of course! They earned it, not the government. However, we still need to pay for the government we live under, which is not cheap.
We could have a tax on wealth instead of a tax on income. But, a wealth tax would invariably limit investing, which would have huge negative consequences under our economic system. We need investment money to run banks, providing loans for houses and businesses, and for funding the stock market. However, if you applied the wealth tax at one time, say immediately after their death, then you could effectively tax wealth without limiting investment. Hmm... let's call that an estate tax. Given that the income tax is paid every year and the wealth tax is paid once, a high percentage for the estate tax is justified.
Any way you look at it, we need to pay for the government we live under. But if you only taxed wealth, then you wouldn't collect from the majority of the people who have no accumulated assets. If you only taxed income, then you'd miss out on the huge wealth hoarded by individuals over their lifetimes. Taxing only income nor taxing only wealth is right, better to have both the income and estate taxes.
Under the estate tax, the wealthy still have the right to give their money to whomever they wish. This law just limits the amount to a specific percentage after a rather large threshold is met. That threshold is high enough that most Americans will never meet it.
Having both an income and a wealth tax in the the form of an estate tax is extremely fair, making sure that everyone contributes to society.
May 6, 2007 7:25 PM | Reply | Permalink
thosethingswesay.blogspot.com
To be fair aMike, and I suspect you already know this... Carnegie was very good at making money but he's no philosopher and he wasn't even a very good art collector.
His only authority as a commentator is that he was once rich.
And now he's dead.
So, seriously... who cares what Carnegie thinks?
May 6, 2007 7:46 PM | Reply | Permalink
Well, not entirely. I pointed to his philanthropy, not his status as an intellectual. Certainly he was no philosopher...he had a grade school education. But, give him credit for practicing what he preached. He was one of the most enlightened philanthropists of his time or any other. During his lifetime he gave away more than $350,000.000.00. What that would be in 2007 dollars I'll let someone with more arithmetical ability than I have figure out. Among his premier endowments:
The Carnegie Libraries are fascinating. If you have some time check out that particular link. The other bullets link to some of his other primary philanthropic efforts. There were others as well. Carnegie may be dead, but good work is still being done by institutions he founded or supported.
aMike
May 6, 2007 9:22 PM | Reply | Permalink
While the tax itself is imposed on the estate or on the heirs (that is, those are the individuals responsible for paying it and no doubt there is something held up (e.g. transfer of title or goverment benefits) until it happens), the act that is being taxed is death itself. With an estate or inheritance tax, while death is a prerequisite, it is not death that is being taxed -- it is the transfer of wealth that occurs on death. And the tax itself is measured with respect to the value of the wealth transferred, in one measure or another.
May 7, 2007 7:04 AM | Reply | Permalink
The word was, "some" and I'm not referring to Gates per se, although, I'm glad he's given what he has to mitigating world health threats that keep people from being able to develop their own back yards.
Having said that, I'm simply pointing out that not all rich folks are greedy people. It's a pretty simple comment designed to signal that I'm aware of exceptions. Not to include it is to invite over-generalization charges.
I hope you're recognizing the exceptions too, and that some have given it all away and disappeared from the scene. Rare, but it happens.
May 7, 2007 11:44 AM | Reply | Permalink
Think about what taking over a business for zero cost would do to the competitive balance of the market. Imagine that you want to start up an antique store. You will need space to house it, plus an initial investment to stock it.
Imagine there is an antique store in town, but the owner is getting on in years. But he owns his own building, he owns the stuff inside it.
Now imagine that the owner dies and leaves the business to his daughter. She doesn't have to acquire space. She doesn't have to acquire inventory.
Her low-cost entry into the market skews it. You can't compete with her because she has costs that were sunk long ago. The longer ago the costs were sunk, the better position the business is in.
While the "family business" may be romantic, it would seem to have the effect of stifling entry into markets. If the Wal-Mart heirs had to pay taxes on their windfall, they might have to raise prices to the point where other companies can compete with them.
May 10, 2007 1:09 PM | Reply | Permalink
Re: You can't compete with her because she has costs that were sunk long ago.
But this is true of any established business whether it changes hands or not. If the old guy in your scenario ends up living as long as Methusalah his business will always have the advantage of being long since capitalized. Are you suggesting buisinesses should have a sunset period to allow new entrants an easier time of getting starting? Sixty years and the government shuts you down?
May 13, 2007 5:59 AM | Reply | Permalink
In several European countries they have a "wealth tax." I don't know the details but I think it's a worthwhile idea. I have nothing against some wealth accumulation, but when 1% of a population owns more than 95% of everything (and yeah, I pulled those statistics right out of the air) it's time to redistribute.
I am not opposed to capitalism - as long as the deck isn't stacked too heavily in favor of the capitalists. Now however, we are seeing democracy turned into a dead letter because an investment of millions in lobbyists magically turns into billions in tax breaks or government contracts.
Cuts in progressive taxes have pushed expenses to the states, which raise regressive fees and taxes like sales taxes.
It's no accident that the massive transfer of wealth away from the middle and lower classes to the rich coincided with the Reagan thru Bush tax cuts. (Most people forget that Reagan presided over the largest tax increase in history - a gasoline tax hike. Since that was a regressive tax that barely affected the wealthy, it didn't bother him. BTW, I would support a much larger increase in the gasoline tax as a conservation measure if it was counterbalanced by increased subsidies for public transportation and other measures to soften the impact on the lower economic brackets.)
It's time for a progressive revolution - hopefully peaceful. If serious changes don't happen soon we will see outright fascism, a French style bloodbath - or both.
"These are the times that try men's souls."
May 13, 2007 8:21 PM | Reply | Permalink
Even counting the "some" who are generous, recent studies have shown that the poor and middle class are far more generous per capita as a percentage of income than the wealthy. Often these charitable deductions are really a means of keeping control of vast wealth - who votes the "donated" stock?
I would favor complete elimination of the charitable deduction. Most of the charities do work better performed by government. Food banks for example, are a disgrace! How could such things possibly be necessary in the richest country in the world? Don't misunderstand - they are necessary - now. If I had my way, every citizen would get food stamps for the asking - simple as that.
May 13, 2007 9:00 PM | Reply | Permalink
My question is, why should a working stiff pay taxes on the income he earns while unearned income of the wealthy is exempt?
Through one strategem after another, the tax burden has been shifted to the poor.
I hear constantly that "The rich pay most of the taxes."
Nonsense! Every calculation to that effect omits consideration of the SS tax - which is capped - and the hundreds of regressive taxes (sales, gasoline, utilities,"sin taxes", licences - even traffic fines)imposed by state and local governments - which jumped dramaticly (remember "revenue enhancements?) after the Reagan tax cuts and the resultant reduction in revenue sharing.
Somebody has to pay taxes. Why not a dead rich guy rather than a struggling young family?
May 13, 2007 9:21 PM | Reply | Permalink
It would be a simple matter in such cases to defer the tax until the eventual sale, as capital gains are not taxed until the asset is sold. I often wonder if these conundrums are purposely written into the laws by cynics who oppose the law in the first place - just to provide such an argument.
May 13, 2007 9:43 PM | Reply | Permalink