Negative Impact of Estate Tax

In economics, inheritance means transfer of unconsumed assets from one generation to the next. The goal of estate tax is to reduce the volume of such transfer. Adam Smith in his work, The Wealth of Nations, commented that all taxes upon the transference of property of every kind, so far as they diminish the capital value of that property, tend to diminish the funds destined for the maintenance of productive labor.

Estate tax is nothing but another tax on savings and investments which are already under heavy taxation – income is taxed when it is earned, interest derived from investments and savings is taxed, appreciated value of an asset is taxed (capital gains tax).

A study by well-known economists Henry Aaron and Alicia Munnell concluded that estate taxes are unfair, raise little revenue, impose excess burdens, and have failed to achieve their intended purposes.

Estate taxes reduce the amount of capital available in the economy and thereby reduce the wealth ultimately available to the society. It encourages consumption and discourages savings. It reduces the after-tax return on investment. This causes the capital stock growth to decrease. Capital is vital to economic growth. Estate taxes impede the accumulation of capital. This has a negative impact on economic growth.

Estate tax liquidates and transfers to government control privately held assets which could otherwise be used for maximizing economic efficiency. Instead they are transferred to consumption-intensive government uses.

Estate taxes discourage entrepreneurial activity, hinders entry into self-employment, and breaks up family-owned businesses – a critical component of the U.S. economy. For people of lower income households to move to higher income groups, entrepreneurship is the key. Estate tax prevents upward income mobility by disrupting the transmission of a family business to succeeding generations.

Studies have shown that the estate tax continues to be a primary reason why small businesses fail to survive beyond one generation. Many heirs have cited the need to raise funds to pay estate taxes as the reason why their family business failed. Planning for estate taxes reduces the resources available for investment and employment. Business owners tend to keep liquid assets available to pay off future estate taxes. Estate tax imposes large cash demands on family businesses that generally have limited access to liquid assets.

In a tax system that is fair, individuals with fewer resources pay less taxes than those with greater resources, and all taxpayers with the same amount of resources pay the same tax. However, the rich can afford to use various estate planning options to reduce or avoid estate taxes, and the poor who cannot afford estate planning end up paying more. There are many tax avoidance options available to the general public. To avoid estate taxes, capital owners shift resources from their most productive uses into less efficient but more tax-friendly uses.

Estate tax is extremely primitive and can result in inefficient allocation of resources. The maximum rate for estate tax is presently 45%. It discourages savings and investments and lowers the after-tax return on investments. Estate tax violates the basic principles of an efficient tax system.

America’s Most Effective Weapon Against the Rich

Inheritance is a civil right and not a natural right. Way back in 1898, the Supreme Court ruled that the right to take property by devise or descent is the creature of the law and not a natural right. The government had the absolute right to decide as to the terms upon which a person should receive a bequest or devise from another. Limitations on inheritance offer equality of opportunity. Taxing inheritance at the source is fairer than taxing income earned as a result of hard work and effort.

Estate tax legislation was first passed in 1916 as a response to the excesses of the Gilded Age. The objective was to shift the tax burden from the Midwestern and Southern states to the rich Northeastern states. The tax burden in those days was mainly in the form of tariff duties and excise taxes. The legislation was recognition that democracy was at risk if too much wealth and power was concentrated in the hands of a few.

One cannot deny the contribution of estate tax to the progressivity of the tax system. The estate tax is the most progressive of any of the federal taxes. The main objective of estate tax is to reduce inequality of wealth and income. It basically applies only to the rich.

Only the super rich stand to benefit from the repealing of estate tax. Without estate tax, billions of dollars in revenue would be lost. The revenue loss over the next decade could be over a trillion dollars. This, at a time of record deficit, could impose an unconscionable burden on future generations. The trade deficit is at a historic high of $61 billion and growing. There are no plans or methods to repay it. This can plunge the U.S. into a drastic economic depression at any time. To make up for this, the government will have to increase taxation or cut Social Security, Medicare, environmental protection and many other government programs which are essential for the overall development of the nation. Any cut or decrease in these programs would be unfair and life-changing to middle class Americans and to the needy, children, elderly, and disabled.

Estate tax also encourages contributions to charity. The present system of estate tax afford the affluent a way of reducing the size of their estates by making contributions to charity. In fact the system operates as an incentive to contribute to charity.

Opponents of the estate tax system harp that it has led to many middle-class Americans losing their estate because of the taxes owed. This has been proved wrong by a study conducted by an organization called United for a Fair Economy. When the exemption increases to $3.5 million in 2009, the share of estates taxed will be about 0.16%. Rest of the estates will pass to the heirs tax free.

Another favorite argument of the critics is that estate tax is a form of double taxation – the estate holder has already paid income taxes and property taxes. Estate tax is not a tax on the estate-holder. It is a tax on the heirs who inherit the estate as an unearned gift.

Repealing of the estate tax will only benefit the rich. Middle class Americans will end up paying more taxes to make up for the revenue deficit.