December 15, 1998
by: Micah Frankel, Associate Dean
Capitalism generates inequality of outcome, and hence envy. When filtered through liberal-speak class-warfare rhetoric, envy translates into fairness. The estate tax or death tax is a classic example of the political exploitation of this envy cloaked in the egalitarian terms of fairness.
The death (or envy) tax is a tax on the transfer of wealth at the time of death. Besides raising revenue to fund the hyperactive government spending juggernaut, death taxes serve several dubious functions.
Death taxes serve to eliminate the alleged negative externality created by entrepreneurs: inequality of outcomes and crime. Estate taxes punish entrepreneurs by creating disincentives for investment and risk taking. When the entrepreneur dies, the government confiscates between 37 to 60 percent of the entrepreneurial firm's assets. This creates disincentives to invest, save and take risks. After all, a large percentage of the fruits of your labor will end up going to estate planning lawyers and the IRS.
Many feel that entrepreneurial energy, talent, ingenuity and risk-taking have created an unequal society. Some people become rich due to hard work, thrift, self-reliance, diligence etc. while others characterized by indolence, dependency, indifference to consequences etc. live in poverty. If you believe as does the secular left that poverty causes crime, it can be argued that entrepreneurs are a leading root cause of crime in the US. Death taxes simply serve to eliminate the detrimental consequences of inequality of outcome (i.e., crime) that result from the entrepreneurial spirit. In fact, however, entrepreneurship creates more wealth for all who participate in the market process.
It appears that death taxes also serve religious or more accurately sacrilegious purpose. 1 The pursuit of money after all is the root of all evil. Therefore, the argument goes, the more money one has the more he must have selfishly and avariciously pursued evil. Ergo, death taxes are an ideal way of extracting and redistributing wealth from these evil greedy capitalist horders to the benevolent unselfish economically challenged. In the words of statist theologian Karl Marx, redistributing income from the bourgeois to the proletariat leads to the redistribution of economic power in the same direction. In the words of Deputy Treasury Secretary Larry Summers people who advocate cutting or abolishing the estate tax have "no case other then selfishness. In terms of substance arguments this estate tax argument is about as bad as it gets."2 In other words, selfish people save money to give to their heirs, while unselfish people consume their wealth before they die.
Last, besides being greedy, some feel that successful people such as entrepreneurs are just plain lucky. For example, Robert McIntyre of the Center on Budget and Policy Priorities and adviser to Rep. Richard Gephardt supported high taxes on the wealthy because these people are "the beneficiaries of life's lottery." Yes, making money has little or nothing to do with entrepreneurial risk taking and innovation, talent, hard-work or self-discipline, it is all luck. You might as well relax and play the slot machines. Many people extend the luck theory of wealth to include inherited wealth. To them, death taxes redistribute unearned inherited riches from the favored affluent to the less fortunate.
To the fore-mentioned people the secondary consequences or even the general consequences of death taxes are considered irrelevant or are just ignored. At the risk of being called selfish and immoral let's take a closer look.
Despite the fact that wealth has increased greatly over the last twenty years, the importance of death taxes to the federal government have been declining. Between 1974 and 1994, there has only been a 0.6 percent inflation adjusted increase in federal estate and gift tax revenue. On a per capita basis, inflation adjusted estate tax revenues were one third lower between 1977 and 1995.3 This is in spite of the fact that the effective tax rates on assets (not income) at death range from an onerous 37 to an oppressive 60 percent.4
An examination of IRS data reveals that in 1996 approximately 86,000 estate tax returns were filed (of which 12,450 were audited) generating about 17.5 billion in gross revenues, this amount was about 1 percent of total gross IRS collections.5 Of these collections, it is estimated that as much as 75 percent were used to cover the costs of the IRS, the Treasury Department, and litigation of estate taxes.6 Compliance costs to taxpayers further increase the burden of these taxes. A Douglas Bernheim study argues that the federal estate tax may actually reduce overall revenues (due to the loss of income tax receipts due to estate planning), even aside from its adverse effects on savings and economic growth.7 In short, the estate tax is extremely inefficient uneconomical method of raising revenue.
There is a growing perception among enlightened liberals that the estate tax is failing to achieve its public policy purpose, principally the generation of economic benefits for economically-challenged Americans. For although the various "wealthy" estates submit the tax to the IRS, the people that the wealth redistribution was intended to aid often bear the burden of estate taxes. For this reason, leading bastions of democratic socialism such as Israel, Canada, and Australia, as well as States such as California have repealed the death taxes.
Unlike consumption which is subject to only one layer of tax which is levied when the income being consumed is earned, savings and investment are subject to four punishing layers of taxation, death taxes being the last. These layers increase the cost of capital which reduces productivity, growth and the standard of living. "It is no exaggeration that the level of income in the United States could be at least 15% to 20% higher than it is today if these biases did not exist. That missing income has simply been thrown away to no good purpose. These losses could amount to as much as $4,000 to $6,000 per year for typical middle income families."8
Although there is a myriad of respected studies (each using different methodologies and econometric models) which concluded that estate taxes should be eliminated, for the sake of brevity, here are five. In 1978, Joseph Stiglitz, Chairman of President Clinton's Council of Economic Advisers concluded that "the estate tax may lead to greater inequality because of reduced savings."9 High estate taxes encourage consumption rather than savings. A lower savings rate makes capital more scarce and hence more costly. "Thus, the estate tax increases returns to owners of capital while lowering productivity and real wages for workers."10
In 1993 a Center for the Study of Taxation analysis concluded that eliminating the estate tax would increase GDP by over $79 billion, lead to a $630 billion increase in savings and capital accumulation, and create over 228,000 additional more jobs over a seven-year period. 11 Richard Wagner a professor at George Mason University estimated that repealing the estate tax would boost GDP by $80 billion, generate 250,000 new jobs and a $640 billion greater capital stock over eight years. 12 Along the same lines, a Heritage Foundation study using two different econometric models presents data which shows that eliminating the estate tax would increase GDP by $100 billion, create 145,000 new jobs, and increase personal income by $72 billion over a nine year period. 13
In 1995, Astrachan and Aronoff found that over half of the minority businesses that they surveyed had taken costly yet unproductive actions in an effort to lessen the burden of estate taxes. In addition 58 percent of the minority businesses in the survey expected failure or great difficulty remaining in business after calculating their estate taxes.14
As an example of how estate taxes result in a "hostile takeover" by the government consider the example of the African-American journalist John H. Sengstacke.15 Through a life-time of "bourgeois virtues" of hard work, thrift, self-reliance, sobriety etc., Mr. Sengstacke built a newspaper empire that included the famous Chicago Defender which was a leading voice for integration of the armed forces, sports, education etc.
In 1997, when Mr. Sengstacke died at age 84, His company was worth approximately $10 million. Even with his estate plan, his heirs still ended up owing the IRS $4 million. Like most small businesses, Mr. Sengstacke's heirs were dealt a triple blow. First they had to cope with the sorrow and grief resulting from the loss of a friend and or family member. Second, they had to resolve the management turmoil resulting from the leadership vacuum resulting the CEO - Mr. Sengstacke's death. Last to add insult to injury they had to deal with the added burden of the estate taxes that eventually doomed the family business. His heirs are being forced to sell the business to pay the estate taxes. This sale triggered by estate taxes has appalled the Sengstacke heirs and some black leaders who still can't believe that estate taxes have forced "the sale of the country's major black newspaper chain out from under the family."
Layer 1 -- Mr. Sengstacke paid tax on his initial earnings.
Layer 2 -- Mr. Sengstacke didn't consume all his after tax earnings, he saved a good portion and was rewarded by being taxed on the income his initial savings generated - i.e., the reinvested earnings in his business, and interest income.
Layer 3 -- Mr. Sengstacke paid personal income tax on any dividends that his corporation distributed from its after-tax income.
Layer 4 -- Mr. Sengstacke selfishly did not consume all his wealth before he died and as a result, the remaining "unspent" assets (not just income) of his estate were taxed again.
According to our current tax system, if Mr. Sengstacke were smart (i.e., he followed the incentives of the tax laws), he would have spent all his money and not saved or invested it. Following this strategy he would have only been subject to one layer of taxation rather than three
Studies have found that 60 percent of all family businesses fail to survive the second generation, and 90 percent do not make it to the third. The major culprit is the estate tax.16 The same tax that imposes costly, punitive rates of taxation that inhibit investment and entrepreneurship on new small businesses, which traditionally have served as economic havens for minority families and launching pads for young workers also destroys family businesses and the economic growth and jobs that are part and parcel of these businesses. 17
Repeal of the fiscally inconsequential yet economically and socially destructive death tax (estate and gift taxes) and its harmful economic and social results is long overdue.
Footnotes
1. According to the statist theologians, death taxes are a undeniable tenet of secular faith. Just as the Lord of heaven taketh the soul, so too must the Lord of hell (the government) taketh the wealth.
2. Alan Reynolds, "Death to Destructive Taxes ñ Good Economics." The Wall Street Journal, May 1, 1997.
3. Raymond J. Keating Chief Economist for the Small Business Survival Foundation "The Estate Tax: Not Worth All the Trouble" and also "The Estate Tax: Another Case of Envy Run Amok." Small Business Survival Foundation Tax Watch. December 1996.
4. An additional 5 percent surcharge is levied on estate of values between $10 million and $21 million, raising the top tax rate from 55 to 60 percent.
5. 1996 IRS Data Book.
6. See the testimony of the Small Business Council of America before the US House Committee on Small Business on January 31, 1995.
7. B. Douglas Bernheim, "Does the Estate Tax Raise Revenue?" in Tax Policy and the Economy, Vol. 1, ed. Lawrence H. Summers (Cambridge, Mass.: National Bureau of Economic Research and MIT Press. Journals,1987), pp. 121-132.
8.Stephen Entin "Tax Biases Against Saving And Investment And How To Fix Them," National Commission on Economic Growth and Tax Reform 1996
9. Joseph E. Stiglitz, "Notes on Estate Taxes, Redistribution, and the Concept of Balanced Growth Path Incidence," Journal of Political Economy, Vol. 86 (1978), Supplement, pp. 137-150.
10. Alan Reynolds, "Death to Destructive Taxes ñ Good Economics." The Wall Street Journal, May 1, 1997.
11. Federal Estate and Gift Taxes: Are They Worth the Cost?, Center for the Study of Taxation, 1996, pp. 9-11.
12. Richard E. Wagner, Federal Transfer Taxation: A Study in Social Cost (Washington, D.C.: Institute for Research on the Economics of Taxation, 1993).
13. William W. Beach, John M. Olin Senior Fellow in Economics "The Case for Repealing the Estate Tax;", The Heritage Foundation Backgrounder No. 1091, August 21, 1996.
14. Joseph H. Astachan and Graig E. Aronoff, "A Report on the Impact of the Federal Estate Tax: A Study of Two Industry Groups," Family Enterprise Center of the Coles College of Business, Kennesaw State College, July 24, 1995.
15. Eric Herman; "The Man Who Couldn't Let Go," SmartMoney, December 1998.
16. Grace W. Weinstein; "Keeping the Family Business in the Family," Investor's Business Daily, April 12, 1995, page 1.
17. William W. Beach, "The Case for Repealing the Estate Tax;", The Heritage Foundation Backgrounder No. 1091, August 21, 1996