Estate/Death Tax Repeal: Not Nirvana, Not a Disaster, But Well Worth It

Under current law, the estate tax, or as its opponents call it, the “death tax,” is scheduled to expire in 2010 and return in 2011 roughly in its 2003 (corrected-earlier version of this post had 2001) form. Lawmakers are currently focusing their attention on total and permanent repeal.

Earlier this week the House voted for permanent repeal by a pretty convincing 110-vote margin. Senate passage will be more difficult, with at least a couple of Republicans on record as being against it.

My points about the end of the estate/death tax are:

- On balance, it’s a really good idea.
- It’s not the nirvana that proponents want us to believe it is.
- It’s not the public-policy disaster opponents want us to be afraid of.

It’s a good idea simply because:

• It eliminates a lot of the costly machinations of the estate-planning industry accountants and lawyers, whose members can mostly move on to other, more value-creating endeavors.
• It will eliminate many of the games families play in the final years of a person’s life to empty as much as possible out of a person’s estate.
• It has the potential to end the creation of new foundations whose missions often begin well, but which all too often end up being self-perpetuating bureaucracies working against the intentions of their original creators.
• It will prevent forced liquidations of valuable properties at fire-sale prices. These forced sales occur not for any sound economic reason, but only because the families involved didn’t feed the estate-planning industry and spend many hours of time and thousands of dollars on what, in a rational world, would be nonproductive time building an estate tax-minimizing labyrinth.

It’s not the panacea its proponents anticipate, or the disaster-in-waiting opponents fear, because:

• Many states will still have estate taxes (go HERE and scroll down 80% of the page for a 2-paragraph overview of what different states do). In states where the rates are high, the planning industry may still have plenty of work and the family games may continue. One would hope that federal elimination might drive similar movements in the states that attempt to keep their estate/death or inheritance taxes.
• Charity-minded heirs will still be able to donate money to causes they like without feeling compelled to create foundations to shelter very large amounts of money. They may of course choose to create foundations to focus their charitable efforts, but the super-rich won’t have to do it as a mechanism merely to keep large amounts of wealth away from the tax man.
• Most importantly, at least as attempts at total repeal have been legislated in the past (this could change), capital gains taxes will be still be assessed when property is eventually sold by heirs, based on the ORIGINAL buyer’s ORIGINAL cost.

Let’s go through an illustration. Assume that Great-Grandma, a widow, owns property originally purchased by Great-Grandpa for $10,000. That property is worth $10 million today.

If Great-Grandma passes away in 2011, and the “2003 rules” have kicked back in, and with an estate plan that gives nothing to charity, her estate will face an estate/death tax of at least $4 million. The property will have to be sold, and fairly quickly, and probably for a lower price than would be realized in a normal-speed sale. This would of course lower the tax bill a bit, but would still be an action forced by the tax law, not economic opportunity. Her heirs would get what’s left over.

If, instead, the estate/death tax is permanently repealed at the time Great-Grandma dies, the heirs would receive the property with no tax consequence. If the property is worth $15 million ten years later in 2021 and the heirs choose to sell, they will owe capital gains tax on a gain of $14,990,000 ($15 million minus Great-Grandma’s $10,000 original cost), which, if the capital gains rate remains at its current rate of 15%, would generate tax of about $2.2 million.

The heirs can of course keep the property and never sell it, but the fact that they have control over it and are under no compulsion to sell means that they can wait for the most opportune time to do so from their perspective. From an economic freedom standpoint, this is the ideal setup. The timing of a sale (or partial sale, depending on the nature of the property) could be driven by personal circumstances (putting kids through college, helping grandkids or others, raising capital to start up a new business, or any number of other things), by considerations of getting the best price in the best market conditions, or both.

There is a fair chance that the freer flow of capital to its best use will generate more in capital gains taxes over time, as property changes hands more frequently, than the take of the one-time vulturous hit of the estate tax. Even if it doesn’t, wealth creation over time will probably be greater, as property is more likely to be put to its highest use when it makes sense to do so, not forced onto the market when a person happens to die.

So it’s clear, at least to me, that proponents packaging estate/death tax repeal as a permanent tax dodge are exaggerating its benefits, and that opponents shouldn’t fret so much about supposedly massive losses of revenue to the government as the parents of Baby-Boomers, and the Boomers themselves, pass on. But after cutting through the hype of supporters and the manufactured dread of opponents, I don’t think there’s any doubt that permanent estate/death tax repeal is an idea whose time has come.

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UPDATE:

USA Today notes that: “…certain estates worth between $1.3 million and $3.5 million would generate more in taxes after the repeal takes effect. That’s because by 2009 the amount exempted from the estate tax is set to rise to $3.5 million. But the amount that can be shielded from the gains tax is set at $1.3 million per heir.”

I’m not sure of the accuracy of this paragraph, because as I understand it, there would be no capital-gains exemption in the case of full repeal. But if there turns out to be a cap-gains exemption of $1.3 mil, the central point of the example above would stand, even though Great-Grandma’s estate/death tax might be a bit under instead of over $4 million if 2003 rules are in place, and the heirs’ capital gains tax on the 2021 sale would be about $2 mil instead of $2.2 mil.

UPDATE 2:

An editorial in Thursday’s Wall Street Journal (not linked, paid subscription required) notes a Joint Economic Committe study indicating that “For every dollar of tax revenue raised by the estate tax, another dollar is squandered in the economy simply to comply with or avoid the tax.” What a waste.