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You Can’t Take It With You…

By D. Eric Schansberg

Professor of Economics at Indiana University Southeast

It has been said that the only sure things in life are death and taxes. It seems that Democrats are fond of combining the two-- especially for the wealthy and the working poor.

Opposition from Democrats to the "estate tax" is well-established. Their political savvy combined with a lack of political resolve by Senate Republicans resulted in a bizarre set of changes to the federal estate tax in 2001. Under the "reform", the estate tax will be reduced from 2002 to 2009-- as exempted wealth increases dramatically (from $1 million to $3.5 million per person) and as the top marginal tax rates gradually decreases (from 50% to 45%). Then, the estate tax will be completely repealed in 2010 before reverting back to the exempted wealth amount we had in 2002 and the top marginal tax rate we had in 2001. It's enough to make one wonder whether the War on Drugs is being waged effectively within the halls of Congress!

Estate taxes are inefficient. Those looking to avoid estate taxes routinely spend tens of thousands of dollars for "estate planning"-- legal, accounting, and financial-planning services to limit their exposure to the tax. This has become more absurd since 2001. The wealthy now need many different "plans"-- many to deal with the nearly annual changes in the law and one more to deal with the one-year (and perhaps future/permanent) repeal. 

Beyond that, there are legal and accounting costs of tax compliance at death. Note also that compliance costs extend beyond those who pay the estate tax to those who must merely convince the IRS why they don't have to pay any estate tax. (More than half of estate-tax returns are filed to prove no tax burden.)

There are a number of other important considerations that impinge on small business. Both planning and compliance are more complex (and expensive) for small businesses. And a number of small business owners purchase (taxable and expensive) life insurance policies to cover future estate taxes-- since estate taxes are based on assets but must be paid out of income.

Of course, all of this also harms the economy-- in terms of job growth, productivity, standards of living, and so on. Beyond the diversion of resources from productive uses toward tax evasion and tax avoidance, estate taxes also create disincentives to work and to save. Although estate taxes are not a trivial component of the federal budget (raising $24.8 billion in 2004-- 1.3% of federal revenues), given the disincentives and their drain on the economic growth, economists have estimated that overall tax revenues would actually increase without this tax.

Estate taxes are also, in most people's minds, inequitable. First, an estate tax is "double taxation"; earned income has already been taxed once in life and then is taxed again at death. Second, the burdens described above are more likely to fall on-- and be relatively less burdensome for-- those with tremendous wealth and those whose wealth is not tied into the assets of a small business or farm.

On the other side of the income distribution, "contributions" to Social Security could represent the vast majority of assets for the working poor and the lower-middle class. Yet Democrats are fond of defending the status quo on Social Security, including its brutal 12.4% tax on every dollar earned up to $90,000. At least, they're consistent. For those who die relatively early, Social Security is the ultimate estate tax-- a 100% tax on what would otherwise be a huge asset for the working poor. And it turns out that the poor and especially the uneducated die earlier than average and are less likely to receive survivor benefits from Social Security. (For example, college graduates live, on average, ten years longer than high-school dropouts.)

The Republicans are the party of social conservatives and the wealthy. And I think I understand why Democrats proclaim themselves to be "friends of the middle class". They enjoy taxing the wealthy and the working poor. And they enjoy promoting a complicated estate tax that increases the demand for the services of middle-income and upper-middle income lawyers, accountants, and financial planners. Only Libertarians emerge as serious proponents of reduced taxation-- on small business, the poor, and the dead.

D. Eric Schansberg

Professor of Economics at Indiana University Southeast

Adjunct Scholar for the Indiana Policy Review and the Acton Institute

Author of Turn Neither to the Right nor to the Left: A Thinking Christian's Guide to Politics and Public Policy

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