Policy feasibility analysis of permanent estate tax elimination

Permanent Elimination of the Estate Tax:

Policy Feasibility Analysis

The objective of this work is to apply critical analysis of permanent elimination of he estate tax in terms of whether this is a good policy alternative and in terms of political feasibility.

In the past few years, repeal of the estate tax has taken a prominent position among legislative topics for debate. Various reports cover this issue and analysis has been applied to the feasibility of this permanent eliminate of the estate tax with many differentially derived conclusions. This work will demonstrate that positive effects and negative affects will occur from permanent elimination of the estate tax law and will attempt to determine which alternative in this policy issue is more feasible overall.

COMPUTERIZED MODEL ESTIMATION GOVERNMENT REVENUE CHANGES

The work entitled: "The Effects on Government Revenues from Repealing the Federal Estate Tax and Limiting the Step-up in Basis for Taxing Capital Gains" published by CONSAD Research Corporation in Pittsburg, Pennsylvania states that presently the tax is scheduled to be phased out in 2010 and eliminated and then scheduled for reinstatement in 2001. CONSAD Research Corporation developed a computer model for making estimation of the changes in government revenue that will take place under specific proposals and the first being "repeal the estate tax" (CONSAD, 2003) and the second being "limit the degree to which the step=up in the basis for measuring taxable capital gains can be applied to the value of assets in estates." CONSAD, 2003) According to CONSAD's report "there are several adaptations of economic behavior in response to such a change in tax structure that would offset most, if not all, of the revenues forgone by the repeal of the estate tax." (CONSAD, 2003) the adaptations are stated to include: (1) Positive effect on the rate of capital gains realizations by older taxpayers who currently experience a lock-in effect as they age and plan for their demise; (2) as the heirs of currently taxable estates restructure the portfolios of assets that they inherit, they will realize the accrued capital gains in the assets as they are sold. For most inherited assets, these realizations will also be taxed at the capital gains tax rate after the limited step-up in basis allowance has been exhausted. This will generate substantial revenues as assets are sold; and (3) when investment real estate and other depreciable property in an estate receive a stepped-up basis, the new basis established for the property can be depreciated by the heirs for income tax purposes, thereby reducing the income tax revenues received by the government. Imposing a limit on the step-up in basis will reduce the degree to which the new basis of the inherited property can be depreciated without first selling the property and thereby exposing it to the capital gains tax. Until such sale occurs, the limited step-up in basis will decrease the loss in income tax revenue that would have occurred if the property had received an unrestricted stepped-up basis. (CONSAD, 2003) the following chart shows the 'effects on revenues to the Federal Treasury from repeal of the estate tax and limitation of the step-up in basis for measuring taxable capital gains.

Effects on Revenues to the Federal Treasury from Repeal of the Estate Tax and Limitation of the Step-up in the Basis for Measuring Taxable Capital Gains

Revenues in Billions of Dollars)

Source: CONSAD (2003)

According to CONSAD's report added to the impacts on the tax revenues of government that will result from a repeal of the estate tax and limitation of the step=up in the basis for capital gains taxation is a higher cost in collecting estate taxes than in collecting other taxes which includes costs of litigations expenses, appraisal costs, and IRS and other Treasury Department personnel wages. CONSAD's report specifically states: "In effect, the change in tax policy would simultaneously generate additional revenues from an existing, relatively inexpensive tax collection process and abolish a relatively expensive tax collection process, thereby achieving an increase in net government revenues that exceeds the direct increase in tax revenues. Quantitative estimation of the decrease in tax collection costs is beyond the scope of this study, but the available empirical evidence indicates that it would be substantial." (2003; p.4)

III. MORAL CASE AGAINST ESTATE TAX

The work of Edward J. McCafferey entitled: "Grave Robbers: The Moral Case against the Death Tax" published in the CATO Policy Analysis Journal states that:

Because the death tax is a tax on savings, it also almost certainly suppresses economic growth. Some recent studies even suggest that the cost of the tax falls disproportionately on women, minorities, and owners of small businesses. The main defects of the death tax, however, are not matters of dollars and cents alone. Unlike other recent studies, this one does not focus on the economic aspects of the case against the tax. The biggest problem with the death tax is a moral one. The death tax rewards a "die-broke" ethic, whereby the wealthy spend down their wealth on lavish consumption, and discourages economically and socially beneficial intergenerational saving. The tax does not promote traditional liberal ideals of redistribution, equality of opportunity, or fundamental fairness. It turns out that certain appealing and attainable comprehensive tax reform options -- moving toward a progressive consumption tax, which would fall consistently on spending, not work or savings -- far better serve the goals of tax fairness and common sense. reducing or eliminating the death tax and its absurdly high rates should thus have broad bipartisan appeal." (1999)

McCafferey relates that approximately 1 to 2% of individuals who die each year leave behind enough wealth for generation of any estate tax whatsoever. The following chart illustrates that percentage of the federal revenue which is comprised by gift and estate taxes from 1940 through 2003.

Gift and Estate Taxes (Percentage of Federal Revenue)

Source: McCafferey (1999)

McCafferey states additionally that actual revenues derived from taxation of estates has not experienced any notable growth since 1975. McCafferey states that arguments for the tax may be summarized as follows:

1) the tax is an important and growing source of revenue for the government;

2) the tax adds a degree of progressivity to the tax system in a particularly nondistortionary way;

3) the tax serves as a "backstop" to the income tax, which fails to completely tax savings, as it is theoretically committed to doing;

4) the tax breaks up large concentrations of wealth across generations;

5) Inheritances should be taxed away so that everyone begins the game of life on a level playing field, so as to ensure equality of opportunity; and 6) the tax is an important inducement to charitable giving at death." (1999)

McCafferey states that arguments against the estate tax may be summarized as follows:

Revenue in gross is not raised by the estate tax and it may in fact actually result in lost money on net for the federal government when administrative costs, revenue lost to others taxes and general economic distortions are considered;

Even if we accept "progressivity" as a legitimate aim of a fair tax system -- as most Americans do -- the death tax gets its progressivity in the wrong place. It falls on savers, not spenders;

3) Early and naive advocates of death taxes thought that such taxes would not distort behavior because they fell only on wealth that decedents left behind by accident. Now very strong evidence supports the common-sense idea that people are strongly motivated to leave wealth to their heirs. Death taxes distort the behavior and investment decisions of this important class of "intergenerational" savers;

Not only does the income tax not need a "backstop," the income tax is actually a bad tax precisely because it falls on savings, in effect double taxing saving as opposed to immediate consumption. Death taxes compound the error by adding a third tax on savings. A fair tax system should consistently tax spending, not work or savings, and should use progressive rates to meet whatever liberal or redistributive objectives it has;

Death taxes have not contributed to greater equality in America. In fact, the death tax has so many gaps, loopholes, and problems -- and the motivation to pass on wealth to heirs is so strong -- that the current death tax allows precisely the kind of wealth transmission it is designed to prevent or limit;

The tax is an extremely costly, cumbersome, and indirect way to assist charities. Charitable giving can be helped or subsidized within the constraints of any tax system, so the unfair and inefficient death tax is not needed for that end." (McCafferey, 1999)

SUMMARY and CONCLUSION

While the estate tax is in terms of economics inefficient in nature resulting in distortion to decisions in economics and while this tax results in depression of capital stock and results in less-long run growth this tax has driven charitable contributions noted by NBC Evening News on December 19, 2007 to be down by 50% for the 2007 Christmas season. While the tax is costly imposing large costs of compliance both publicly and privately and is extremely difficult to enforce and while the tax further drives consumerism and does not provide a framework for savings at the same time many individuals benefits from donated money through grants and government funding initiatives which is donated by those subject to this type of taxation. The bottom line is that this tax is inequitable in that the tax falls upon the shoulders of the wrong individuals taxing those who manage to save instead of those who are the spenders. The estate tax greatly supports and discourages the very elements that a tax system which is sound in nature should encourage which are "works, savings, thrift, and intergenerational altruism..." (McCafferey, 2007)