(updated May 25, 2010)

Taxation is the involuntary taking of property by force. I’d like to think that all taxes will be repealed and that libertarian thought will ultimately prevail.  But in the real world the public policy issues cannot be so readily resolved. The government runs on tax revenues, rather than printing money.  The question breaks down to which taxes should be imposed.

A serious public policy problem with the estate tax relative to, say, the income tax is that the estate tax is often easy to avoid.  In a sense, the estate tax is a penalty on failure to plan - and the planning often involves screwy financial structures which would not be recommended if the tax did not exist.

Opponents of the estate tax assert that the estate tax is an "unfair double tax." Well, all taxes are inherently unfair.  But the statement has a ring of truth in it in the case of a person who accumulated wealth via the savings of after (income) tax dollars. The situation is even worse in the case of the death of those who die with large IRA’s or retirement plan accounts. Their estate tax burden is computed on the total amount, thus imposing an estate tax on the income tax liability inherent in the IRA or plan balance.

But consider the following public policy arguments in favor of the estate tax:

Bill Gates, arguably the wealthiest man in the world, acquired all his stock in Microsoft when the company was operating out of his garage. He has not paid income taxes on the appreciation of that stock.

Government debt must be addressed.  Estate tax revenues are projected to increase dramatically over the next two decades.

The estate tax is a major weapon against the concentration of wealth.

The incidence of the estate tax falls on beneficiaries who probably did little, if anything, to earn the increase in their wealth.

The estate tax historically has been imposed on only 2% of estates — and half of them pay less than 5% in taxes.

Opponents of the estate tax also argue that the tax retards economic growth and causes a loss of jobs. Certainly, there is a waste of resources in planning to avoid the estate tax, but no one should believe that business owners forego profit opportunities because of the possibility of an estate tax burden.

The post-death burden reduces funds which may otherwise have been available for expansion, but all taxes do that.  Consider that the income tax is designed so that the growth of inventory and accounts receivable occurs with after-tax dollars, effectively making the income tax a direct tax on growth itself.

Further, it is easy to achieve, say, 40% discounts in valuing closely-held businesses for estate tax purposes, in which event the effective maximum estate tax rate is less than 28%. The discounts, coupled with the opportunity to pay the estate tax over 15 years in cases where business interests make up a significant portion of the gross estate, provide significant relief.

The estate tax is said to destroy family farms and other small businesses.  Again, there is a ring of truth to this assertion.  On the other hand, the real estate which constitutes a family farm can be valued at use value, rather than highest and best use (with a maximum valuation reduction of $750,000).  Further, it is often not difficult for a good planner to avoid estate taxation of a small business. In fact, a good planner can not only eliminate estate taxation of a many small businesses, but can actually view small business as a vehicle to avoid estate taxation of other assets. (See "Avoiding Estate Taxation of a Small Business.")

Finally, the important question for you and me is not whether the estate tax SHOULD be repealed, but rather whether it WILL be repealed.

                                   WHAT WILL HAPPEN TO THE ESTATE TAX?

Polls show as much as 77% of the public favors repeal of the estate tax, but that’s misleading.  When the fight becomes real I expect people to be persuaded by the argument that the estate tax is a means of shifting their own tax burdens to others.  Senator Long famously said the guiding principle of tax policy is "Don’t tax you. Don’t tax me. Tax that fellow behind the tree." From that perspective it seems unreasonable to expect 1,000 middle class families to choose to pay $5,000 so that "the son of Mr. Rich" can get another $5 million on his father’s death.  Besides, a majority favors the estate tax when the question is presented as a tradeoff with some government benefit, like Social Security, better roads, etc.

The 2001 tax act repealed the estate tax for 2010, and then reinstalls the pre-act rates and exemptions in 2011!   We will have a $1 million exemption amount on January 1, 2011 unless a new act is passed.   I don’t expect Congress to act before the November elections. 

I do expect PAYGO to be implemented in earnest, which means tax reduction proposals must be accompanied by matching tax increases or spending cuts.  Reforming the alternative minimum tax (AMT) and retaining low capital gains tax rates are higher priorities than estate tax reform.  Since the estate tax rate and the exempt amount are scheduled to increase to pre-2001 figures in 2011, any increases in the exempt amount or reduction in the marginal rates will be considered a tax increase for PAYGO purposes.  

I expect Congress to disallow common valuation discounting techniques, such as family limited partnerships.  Doing so would be a significant revenue generator without increasing taxes.  That is, it could be "sold" as eliminating loopholes.   If I am right, INTERESTS IN MANY FAMILY LIMITED PARTNERSHIPS AND LLC’S WILL NOT BE ELIGIBLE FOR  DISCOUNTS ON DEATH.  STEPS SHOULD BE TAKEN NOW TO LOCK IN THE DISCOUNTS.  

©2010 Steven M. Chamberlain. All rights reserved. Republication with attribution is permitted.