Jane G. Gravelle
Senior Specialist in Economic
Policy
June 8, 2010
Summary
The Economic Growth and Tax
Relief Act of 2001 (EGTRRA; P.L. 107-16), among other tax cuts, provided for a
gradual reduction and elimination of the estate tax. Under EGTRRA, the estate
tax exemption rose from $ 675,000 in 2001 to $ 3.5 million in 2009, and the
rate fell from 55% to 45%. In 2010, the estate tax was eliminated. As with
other provisions of EGTRRA, however, the estate tax changes will sunset in
2011; the exemption will become $ 1 million (as scheduled in pre-EGTRRA law)
and the tax rate will return to 55%.
There is general agreement that
some sort of estate tax will be retained. A proposal to make the 2009 rules ($
3.5 million exemption and 45% rate) permanent was included in President Obama's
2010 and 2011 budget outlines and was passed by the House in December 2009
(H.R. 4154). Senate Democratic leaders have indicated a plan to enact the 2009
rules permanently (and make them retroactive to 2010). The Senate Republican
leadership has proposed a $ 5 million exemption and 35% rate.
With any of the exemption levels,
few estates are affected by the tax. In 2011, the shares of estates taxed are
projected by one study to be 1.76%, 0.25%, and 0.14% for the exemption levels
of $ 1 million, $ 3.5 million, and $ 5 million, respectively. These numbers would
grow to 3%, 0.46%, and 0.23% by 2019. The revenue yield in 2011 is projected to
be $ 34.4 billion, $ 18.1 billion, and $ 11.2 billion for the $ 1 million
exemption/55% rate, $ 3.5 million exemption/45% rate, and the $ 5 million
exemption/35% rate. The estate tax accounts for a small share of revenue.
The estate tax is a highly
progressive tax; it not only applies to the largest estates, but within the
distribution of estates a large share is concentrated in the over $ 20 million
estate level: 62% for the $ 3.5 million exemption/45% rate and 73% for the $ 5
million/35% rate. Because of various exemptions and deductions, the effective
tax rates on estates are much smaller than the statutory rate, with an average
16% rate on estates over $ 20 million for the $ 3.5 million exemption/45% rate
and 12% for the $ 5 million exemption/45% rate. When distributed with respect
to income, 96% falls in the top quintile of the income distribution, 72% in the
top 1%, and 42% in the top 0.1%, under the $ 3.5 million exemption/45% rate.
Although concerns have been
raised about the effects of the tax on small businesses and farmers, estimates
indicate that the share of estate taxes paid by small business estates under
the proposed revisions would be small (16% to 18%) and the share of estates of
small business owners taxed is small (about 0.2% of decedents with at least 50%
of their assets in businesses). Evidence suggests that the number of returns
with inadequate liquid assets to pay the estate tax is negligible.
Other effects are likely small.
The effects on savings are uncertain but likely small relative to the economy
because the tax is small. Moving to either the $ 3.5 million plan or the $ 5
million plan would be projected to decrease charitable contributions by a small
amount: 1% to 2%. Recent evidence suggests that the costs of administration and
compliance are around 7% of revenues.
Structural reforms that might be
considered are inheritance of spousal exemptions, and some reforms directed at
abuses. A provision to restrict Grantor Retained Annuity Trusts (GRATS), which
can be used to virtually eliminate estate tax by providing an annuity with a
remainder, is contained in H.R. 4849. Other provisions in President Obama's
budget outline include restricting discounts for estates left to family
partnerships and conforming fair market value for purposes of the estate tax
and future capital gains realizations for heirs.
Contents
Introduction
Brief Description of the Estate
Tax
Basic Structure
Exemptions and Deductions
Special Provisions for Small Businesses,
Farms, and Landowners
Step Up in Basis for Appreciated Assets
Differences in the Treatment of Bequests
and Gifts
Options for Revision
An Introduction to the Issues
Coverage of Decedents
Liabilities and Revenue Loss
Distributional Issues
Effects on Small Businesses and Farmers
Effects on Savings and Output
Effect on Charitable Contributions
Administrative and Compliance Cost
Other Design Issues
Portability
of the Spousal Exemption
Grantor
Retained Annuity Trusts
Minority
Discounts
Consistent
Valuation
Conclusion
Tables
Table 1. Percentage of Decedents
Subject to Estate Tax
Table 2. Estate Tax Liability
Under Alternative Proposals
Table 3. Estate Tax Liability
2011: Exemption and Rate
Table 4. Percentage Distribution
of Taxable Estate Tax Returns by
Size of Estate, 2011
Table 5. Percentage Distribution
of Estate Tax Revenue by Type of
Return, 2011
Table 6. Effective Estate Tax
Rate (Tax as Percentage of Assets),
2011
Table 7. Distribution of Estate
Taxes by Income Class
Table 8. Coverage of Estates with
At Least Half of Assets in a
Business, 2011
Table 9. Taxes Paid on Small
Business Estates, 2011
Table 10. Number of Farm Estates
or Estates Claiming QFOBI Deductions
with Estate Tax Liability at Different
Exemption Levels
Table 11. Number of Farm Estates
or Estates Claiming QFOBI with
Insufficient Liquid Assets to Pay the Tax
Contacts
Author Contact Information
Introduction
The Economic Growth and Tax
Relief Act of 2001 (EGTRRA; P.L. 107-16), among other tax cuts, provided for a
gradual reduction in the estate tax. The estate tax applies to wealth
transferred at death and had, at that time, a unified exemption for both
lifetime gifts and the estate of $ 675,000.
Under EGTRRA, the estate tax
exemption rose from $ 675,000 in 2001 to $ 3.5 million in 2009, and the top tax
rate fell from 55% to 45%. Although combined estate and gift tax rates are
graduated, the exemption is effectively in the form of a credit that eliminates
tax due at lower rates so there is a flat rate on taxable assets under 2009
law. The gift tax exemption was, however, restricted to $ 1 million.
For 2010, EGTRRA scheduled the
elimination of the estate tax, although it retained the gift tax and its $ 1
million exemption. EGTRRA also provided for a carryover of basis for assets
inherited at death, so that, in contrast with prior law, heirs who sold assets
would have to pay tax on gains accrued during the decedent's lifetime. This
provision has a $ 1.3 million exemption for gain (plus $ 3 million for a
spouse).
As with other provisions of
EGTRRA, the tax revisions expire in 2011, returning the tax provisions to their
pre-EGTRRA levels. The exemption would revert to $ 1 million (a value that had
already been scheduled for pre-EGTRRA law) and the rate to 55% (with some
graduated rates). The carryover basis provision effective in 2010 would be
eliminated (so that heirs will not be taxed on gain accumulated during the
decedent's life when they inherit assets).
Most agree that the 2010
provisions will not be continued, and, indeed, may be repealed retroactively.
President Obama proposed a permanent extension of the 2009 rules (a $ 3.5
million exemption and a 45% tax rate), and the House provided for that permanent
extension on December 3, 2009 (H.R. 4154). The Senate Democratic leadership has
indicated a plan to retroactively reinstate the 2009 rules for 2010 and beyond.
Senate Minority Leader McConnell proposed an alternative of a 35% tax rate and
a $ 5 million exemption. n1 A
similar proposal for a $ 5 million exemption and a 35% rate, which also
includes the ability of the surviving spouse to inherit any unused exemption of
the decedent, is often referred to as Lincoln-Kyl after the two Senators who
have supported it. Proposals have also been to begin with the $ 3.5 million/45%
rate and phase in the $ 5 million/55% rate. Others have argued for a permanent
estate tax repeal. n2
To address abuses and tax
avoidance, President Obama has included proposals in his 2011 budget outline.
One of these proposals, to reform the Grantor Retained Annuity Trust (GRAT), is
included in H.R. 4849. This provision is discussed in detail below.
After a brief description of the
estate and gift tax and of options, this report compares the alternatives,
focusing largely on a $ 1 million exemption and 55% rate, a $ 3.5 million
exemption and a 45% rate, and a $ 5 million exemption and a 35% rate. Several
policy effects and issues are analyzed: the share of decedents subject to tax; revenue
effects; distributional effects; and effects on savings, charitable
contributions, and compliance and administration. The report also considers
other aspects of the proposals, such as whether the exemptions are indexed for
inflation, a proposed inheritance of the exemption for spouses, and proposals
to address perceived abuses.
Brief Description of the Estate
Tax
This section describes the estate
tax as it existed in 2009 and will exist in 2011 absent legislative change. For
2010, there is no estate tax, although the gift tax remains and there is a tax
on gains accumulated during the decedent's lifetime when assets are sold by
heirs (with a $ 1.3 million exemption plus $ 3 million for a spouse). As
mentioned above, few expect this treatment to continue.
Basic Structure
The estate and gift tax is a
unified tax, so that assets transferred as gifts during a person's lifetime are
combined with those transferred at death (bequests) and subject to a single
rate schedule. n3 The tax is
imposed on the decedent's estate and the rate structure applies to total
bequests and gifts given; heirs are not subject to tax. In the past, a single
effective exemption applied, but under the 2001 tax revisions effective in
2009, the gift tax exemption was more limited than the combined exemption for
both estate and gift taxes. Thus, although a unified rate schedule applies to
both bequests and gifts, the exemptions differed in 2009. The combined
exemption was $ 3.5 million, whereas the exemption for gifts was $ 1 million.
In 2011, the combined exemption will be $ 1 million, absent change.
Although the rates of the tax are
graduated, the exemption is applied in the form of a credit and offsets taxes
applied at the lower rates, under the 2009 rules. Under pre-existing law, there
will be some graduated rates on taxable estate amounts between $ 1 million and
$ 3 million because the exemption is not large enough to offset tax at lower
rates. Rates begin at 41% for amounts over $ 1 million and rise by 2 percentage
points at each additional $ 500,000, reaching 53% on amounts between $ 2.5
million and $ 3 million. There is also a 5% surtax designed to phase out the
benefits of lower rates so that very large estates are taxed at a flat 55%
rate. Individuals are also allowed to exempt annual gifts of $ 13,000 per
recipient, which are not counted as part of the lifetime exemption. The annual
gift tax exemption is indexed for inflation in $ 1,000 increments. A generation
skipping tax is also imposed, to address estate tax avoidance through gifts and
bequests to a later generation. n4
Exemptions and Deductions
Estates are allowed to exempt
some assets from the estate tax and take a deduction for selected other
transfers. Transfers between spouses are exempt. Estates are also allowed to
take deductions for charitable contributions and administrative expenses.
Currently estates are also allowed a deduction for taxes paid on estates and
inheritances imposed by states. Prior to 2001, a credit was allowed, subject to
a cap, for state estate taxes, but the credit was phased out and replaced by a
deduction in that legislation. (Should EGTRRA provisions expire, the state
credit would reappear.)
Special Provisions for Small
Businesses, Farms, and Landowners
A series of provisions benefit
small businesses, including farms or landowners. These include the ability of
family businesses to pay the tax in installments with only interest payments
during part of the installment period, special use valuation, conservation
easements, and, if the law reverts to its 2001 rules, a deduction for family
owned business assets. Minority discounts, although granted by courts rather
than specifically in the law, may also benefit small businesses.
Although the estate tax return is
due within nine months of the death, small businesses are allowed to defer
payment (except for interest) for the next five years, and pay the remaining
installment payments over 10 years. Since the last interest payment and the
first installment coincide, the overall delay in full payment is 14 years. The
benefit is allowed only for the business portion of assets and only if 35% of
the estate is in a farm or closely held business.
Small businesses are also allowed
to value their assets at use as a farm or business. This provision is
particularly beneficial to farms and allows a reduction in the estate value of
up to $ 1 million. It means, for example, that the value of the farm will be
what it could be sold for if restricted to farm use rather than, for example,
to be subdivided for development. Heirs are required to continue use as a farm
or business for 10 years.
Farmers and other landowners may
also benefit from conservation easements, a perpetual restriction on the use of
the land where, in addition to the reduction in value due to the easement
itself, an exclusion of up to 40% of the restricted value of the land, capped
at $ 500,000, is allowed.
In prior law, another provision
benefitting small businesses was the Qualified Family Owned Business Income
(QFOBI) deduction. This provision allowed estates with at least half of their
assets in a family business to take a deduction for these business assets. This
provision originally allowed up to $ 675,000 of business deductions at a time
when the basic estate tax exemption was $ 625,000, and imposed an overall cap
of $ 1.3 million on the total of both deductions. Once the regular exemption
passed the $ 1.3 million level, the provision was no longer relevant. If the
2001 tax cuts sunset, the exemption will become $ 1 million and QFOBI will be
relevant again, allowing an additional $ 300,000 exemption. If the $ 3.5 million
exemption is reinstated for 2011, this provision would again become
ineffective, unless revised. To qualify for the QFOBI deduction, heirs must
continue the business for 10 years or the tax saving must be repaid.
Step Up in Basis for Appreciated
Assets
Heirs take as their basis (the
amount to be deducted from the sales price) for purposes of future capital
gains the value of the asset at the date of the decedent's death. This
treatment is referred to as step-up in basis and means that no capital gains
tax is paid on the appreciation of assets during the decedent's lifetime. For
example, if decedent purchased stock for $ 100,000 and the value of the stock
at the time of death is $ 200,000, if the heir sells the property for $ 250,000
a gain of $ 50,000 ($ 250,000 minus the stepped-up basis of $ 200,000) is
recognized. The $ 100,000 of gain that accrued during the decedent's lifetime
is never taxed. The step up rules do not apply to gifts, where carryover basis
is applied. In that case, the original basis of $ 100,000 would be carried over
and the gain would be $ 150,000 ($ 250,000 minus $ 100,000). Both the gain
accrued by the donor and the gain accrued by the donee are taxed. The step-up
rules do not apply to bequests for 2010, where carryover basis, with an
exemption, applies, as noted above.
Differences in the Treatment of
Bequests and Gifts
Aside from the different
exemption levels, there are other differences between the taxation of gifts and
bequests. As noted above, gifts do not benefit from the step up in basis. The
donor takes the basis in the hands of the donor, generally the original cost of
acquiring the assets. The basis cannot be less than the fair market value at
the time of the gift if a loss is realized.
At the same time, the gift tax is
tax exclusive (the tax is imposed on the gift net of the tax) whereas the
estate tax is tax inclusive (the tax is applied to the estate inclusive of the
tax). To illustrate, consider a 50% tax rate. Assuming the exemption is already
used, to provide a gift of $ 1 million costs $ 1.5 million: the tax rate of 50%
is applied to the gift of $ 1 million for a $ 0.5 million tax. To provide a net
amount of $ 1 million for a bequest, $ 2 million is required: a tax of $ 1
million (50% of $ 2 million) and a net to the heir of $ 1 million. Another way
of stating this is that the gift tax rate, if stated as a tax inclusive rate
like the estate tax, would be 33%. Thus for the 55%, 45%, and 35% estate tax
rates, the gift tax rate equivalents are 35%, 31%, and 26%. n5
Options for Revision
The principal components of any
policy that continues the estate tax are the amount of the exemption and the
tax rate. n6 As indicated earlier,
the estate tax will revert to an exemption of $ 1 million, absent a change in
the statute, and while any level of exemption might be considered, the two most
common levels mentioned are $ 3.5 million and $ 5 million. The level of the
exemption affects not only the revenue but the number of estates that are
subject to the tax.
The second principal component of
a continued estate tax is the rate, which will return to 55% absent legislative
change; rates of 45% and 35% are most frequently discussed, although some
proposals would apply the capital gains tax rate (currently 15% but scheduled
to go to 20% in 2011) or some multiple of it.
Another issue is whether to index
the exemption for inflation. Some components of the income tax, such as rate
brackets and standard deductions, are indexed, while others (such as child
credits) are not. Over time, as prices rise, a fixed exemption causes more
estates to be subject to tax. Without indexation, Congress may return from time
to time to reconsider the exemption.
A final issue is the potential
carryforward of an unused estate tax exemption to the surviving spouse. The
provision, contained in the Lincoln-Kyl proposal, would allow spouses to
inherit unused estate tax exemptions. Since bequests to the spouse are excluded
from the estate, the couple together can have a larger total exemption if the first
spouse to die leaves assets to the children or other heirs large enough to
absorb his or her estate exemption. This action will reduce the size of the
estate subject to tax when the second spouse dies. There are reasons, however,
that the taxpayer may prefer to leave more assets to a spouse (for example, if
there are concerns about having enough assets to live in comfort or cover
emergencies). The proposed change is to permit the second spouse to inherit any
unused exemption and add it to his or her own future exemption.
Proposals have also been made to
increase the percentage or dollar limits of special use valuations and
conservation easements. At the same time, there are proposals, including those
in President Obama's budget, to restrict practices considered as abuses. One
proposal, relating to a certain type of trust (a Grantor Retained Annuity Trust
or GRAT) is being considered in H.R. 4849, the Small Business and
Infrastructure Jobs Tax Act of 2010. Another proposal would restrict minority
discounts for estates that are sometimes allowed by courts when no one heir has
a controlling interest in the property. A third provision would require estates
and heirs use the same fair market value in determining the valuation for
purposes of the estate tax and for determining basis in the hands of the heir.
An Introduction to the Issues
Data, other empirical evidence,
and economic theory can help address proposals to revise the estate tax.
Relevant economic issues include the scope and effect of the tax on the total
population and the distribution of the tax, the revenue yield, and the
potential effects on family businesses, savings, administration and compliance,
and charitable giving. To the extent possible, different options are compared
in the context of these issues.
Other issues are perhaps more
philosophical or, as Gale and Slemrod discuss in their article on the estate
tax, rhetorical. n7 For example,
some people oppose the estate tax because they hold a philosophical view that
the estate tax is a death tax and death should not be taxed. Arguments are also
made that estate taxes result in a double tax, because assets have already been
taxed under the income tax and should not be taxed again. Gale and Slemrod do
point out, however, the complexity of the rhetorical questions. For example,
they point out that for the vast majority of people (at the time they were
writing, 98%) death actually brings potential tax benefits through the
forgiveness of tax on accrued but unrealized gains (gains on assets that have
not been sold). They also note that income from unrealized appreciation in
assets is not taxed during the lifetime and so is not subject to double taxation.
They indicate that 36% of estate assets and 80% of the wealth in closely held
business and farm estates is from unrealized appreciation.
Supporters of the estate tax may
believe it is important to constrain the accumulation of wealth generation
after generation. While empirical evidence can demonstrate that the estate tax
is highly progressive, the degree to which taxes should be applied to large
amounts of wealth in pursuit of reducing inequality in society, much like the
question of whether it is wrong for death to trigger a tax, is a value
judgment.
Coverage of Decedents
The estate tax has never affected
more than a small fraction of decedents. Table 1 indicates that if the
law reverts to the $ 1 million exemption, less than 2% of decedents would pay
an estate tax. Table 1 also indicates that restoring the $ 3.5 million
exemption leads to a quarter of 1% of decedents paying the tax. Moving to a $ 5
million exemption reduces the share to 0.14%. The column for 2019 illustrates
the effects of indexing the $ 3.5 million and the $ 5 million for inflation,
starting from 2009. Note that even with indexing for inflation, real asset
growth leads to an increased share of decedents paying the estate tax. With or
without indexing, the $ 3.5 million option will affect less than one-half of 1%
of decedents and the $ 5 million option will affect less than one-fourth of 1%
of decedents. If the main focus of legislation is to exclude all but a small
fraction of estates from the tax, the $ 3.5 million exemption and the $ 5
million exemption accomplish that goal, and indexing does not matter very much
over short time horizons.
Table
1. Percentage of Decedents Subject to Estate Tax
Exemption Level
2011
2019
$ 1 million
1.76
3.00
$ 3.5 million
0.25
0.46
$ 3.5 million, indexed for
inflation
0.24
0.32
$ 5 million
0.14
0.23
$ 5 million, indexed for
inflation
0.14
0.18
Source:
Based on data in Urban Brookings Tax Policy Center, Table
T09-0431,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2506&topic2ID=60&topic3ID=66&DocTypeID=.
Note:
For proposals that are indexed, the indexation begins from 2009.
Liabilities and Revenue Loss
An issue in the choice of estate
tax provisions is the revenue cost. Although the estate tax accounts for a
small share of total federal revenues, 1.3% in 2012 if the $ 1 million
exemption/55% rate provisions are retained, concerns remain about revenue
losses.
Revenue costs are normally
estimated against a current law baseline. Thus, the cost of keeping the 2009
rules in place retroactively to 2010, with a $ 3.5 million exemption and a 45%
tax rate, would be compared to no estate tax in 2010; therefore there would be
a revenue gain compared to no estate tax. In subsequent years, where current
law reverts to a larger estate tax (a $ 1 million exemption and 55% rate) the
smaller estate tax will lead to a revenue loss. Receipts are also measured when
they flow into the Treasury and there is a delay in the filing of estate tax
returns.
The Joint Committee on Taxation
(JCT) in 2009 estimated a gain of $ 0.5 billion in FY2010, then a loss, rising
to $ 38 billion in FY2019 for a total of $ 234 billion over the 10-year period
(FY2010-FY2019). Treasury's estimates are smaller, with a $ 3 billion and a $ 1
billion gain respectively in the first two fiscal years, becoming a $ 28
billion loss by FY2019, and losing $ 171 billion over a 10-year period. n8
Another way to examine the
alternatives is to look at the estimated yield for alternative proposals, that
is, the liability rather than the flow of revenue to the Treasury. Table 2
provides data from the Urban Brookings Tax Policy Center for the three
exemption levels. In 2011, the scheduled rules ($ 1 million exemption, 55%
rate) are estimated to produce a liability of $ 34.4 billion; the $ 3.5 million
exemption, 45% rate a revenue of $ 18.1 billion, and the $ 5 million
exemption/35% rate a revenue of $ 11.5 billion. Thus, in 2010, the reduced
liability from moving to a $ 3.5 million exemption with a 45% rate is $ 16.3
billion, whereas moving to the $ 5 million exemption with a 45% rate loses an
additional $ 6.9 billion, for a total of $ 26.2 billion. The cost increases
over time as the real and nominal value of wealth grows, so that, for example,
the reduction in tax from moving to a $ 3.5 million exemption and 45% rate
increases from $ 16.3 billion in 2011 to $ 30.7 billion in 2019.
Table 2.
Estate Tax Liability Under Alternative Proposals
($
billions)
Exemption Level/Rate
2011 2019
$ 1 million, 55% rate
34.4 62.2
$ 3.5 million/45% rate
18.1 31.5
$ 3.5 million, indexed for
inflation/45% rate
17.9 28.9
$ 5 million/ 35% rate
11.2 20.9
$ 5 million, indexed for
inflation/ 35% rate
11.2 17.9
Source:
Based on data in Urban Brookings Tax Policy Center, Table
T09-0431,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2506&topic2ID=60&topic3ID=66&DocTypeID=.
Notes:
For proposals that are indexed, indexation begins from 2009.
Table 2
also contains estimates of estate tax liability if exemptions are indexed
(assuming indexing back to 2009). Indexing does not make a great deal of
difference over this time period. Real growth in wealth is more important. For
example the difference between revenues in 2011 and 2019 for the $ 3.5 million
exemption/45% rate is $ 13.4 billion but only $ 2.6 billion of the difference
is due to lack of indexing for inflation.
As indicated above, the two
proposals generally discussed are the $ 3.5 million exemption and 45% tax rate,
and the $ 5 million exemption and 35% tax rate. However, various combinations
of rates and exemptions could be considered. Table 3 reports the
estimates of estate tax liability for each of the three exemption levels at
different rates. It shows that, compared with the default $ 1 million
exemption, a larger amount of the revenue loss results from moving to the $ 3.5
million exemption rather than the 45% rate. Similarly, in moving from the $ 1
million to the $ 5 million exemption, the cost of the exemption increase is
smaller than lowering the rate to 35%. However, once the exemption is set a $
3.5 million and the rate at 45%, the cost of moving to a $ 5 million exemption
($ 14.2 billion) is about the same as the cost of moving to a 35% tax rate ($
14.1 billion).
The rate reductions tend to
benefit, relatively, a wealthier group of estates than exemptions, and thus
reduce progressivity of the estate tax. However, rate reductions also reduce
the average marginal tax rate more than exemption increases, which could matter
for economic efficiency. These distributional issues are discussed more fully
in the next section.
Table
3. Estate Tax Liability 2011: Exemption and Rate
($ billions)
Exemption Level
55% rate
45% rate 35%
rate
$ 1 million
34.4
28.1 21.8
$ 3.5 million
22.1 18.1
14.1
$ 5 million
17.4
14.2 11.2
Source:
Based on data in Urban Brookings Tax Policy Center, Table
T09-0431,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2506&topic2ID=60&topic3ID=66&DocTypeID=.
Note:
The revenue effect for lower rates under the $ 1 million
exemption is somewhat overstated
because of the lower graduated rates.
Distributional Issues
One of the rationales for an
estate tax is to impose a tax on high income and high wealth taxpayers, and
contribute to the progressivity of the tax system. As indicated in the discussion
of coverage, all of the proposals fall on a small proportion of decedents and
thus, due to the size of the exemption level, on those with the greatest
wealth. The alternative proposals have different effects on the size of estates
covered and the distribution of taxes.
As indicated in Table 4,
the number of estates is concentrated in the smaller estates. With the $ 1
million exemption, about half of the estates subject to tax have assets of
under $ 2 million and almost 80% have assets of under $ 3.5 million and these
estates would be eliminated from estate tax coverage with either the $ 3.5
million or the $ 5 million exemption. With a $ 3.5 million exemption, the share
of taxable estates under $ 5 million is smaller than the share falling between
$ 5 million to $ 10 million group. Of the returns taxed under the $ 3.5 million
exclusion, 23% are less than $ 5 million in assets and would not be taxed under
the $ 5 million exclusion.
Table 4. Percentage
Distribution of Taxable Estate Tax Returns
by Size of Estate, 2011
$ 1 Million $ 3.5 Million $ 5
Million
Size of
Exemption, Exemption,
Exemption,
Estate
55% Rate 45%
Rate 35%
Rate
($ millions) (44,230
returns) (6,420
returns) (3,560
returns)
1-2
52.2
0.0
0.0
2-3.5
26.0
0.0
0.0
3.5-5
9.1
23.7
0.3
5-10
7.6
44.7
45.2
10-20
2.8
18.7
31.7
Over 20
2.2 12.8
22.5
Total
100.0
100.0
100.0
Source:
Based on data in Urban Brookings Tax Policy Center, Tables
T09-0396, T09-0398, T09-0398,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2471&topic2ID=60&topic3ID=66&DocTypeID=
As shown in Table 5,
revenue from the estate tax is more concentrated in larger estates. The largest
share of revenue is in the $ 20 million and above class regardless of the
exemption. With a return to the $ 1 million exemption that class would pay
one-third of the revenue; with a $ 3.5 million exemption it would pay over 60%
and with a $ 5 million exemption it would pay almost three-quarters of the
estate tax. These estimates indicate that the estate tax not only applies to
high wealth families, but with either the $ 3.5 million or the $ 5 million
exemption more than half the revenue is collected from estates with $ 20
million or more in assets.
Table
5. Percentage Distribution of Estate Tax Revenue
by
Type of Return, 2011
$ 1 Million $ 3.5 Million
$ 5 Million
Size of
Exemption, Exemption,
Exemption,
Estate
55% Rate ($ 34.4
45% Rate ($ 18.1
35% Rate ($ 11.2
($ millions) billion
total)
billion total) billion total)
1-2
7.5
0.0
0.0
2-3.5
15.9
0.0
0.0
3.5-5
10.8
2.4
0.0
5-10
18.3
16.1
9.5
10-20
13.9
18.3
18.0
Over 20
33.7
62.3 72.5
Total
100.0
100.0
100.0
Source:
Based on data in Urban Brookings Tax Policy Center, Tables
T09-0396, T09-0398, T09-0398,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2471&topic2ID=60&topic3ID=66&DocTypeID=
Although the statutory marginal
tax rates are often criticized as being very high, the average share of the
estate paid in tax is much lower. Part of the reason for the lower effective
tax rate is the exemption. For example, even if a $ 10 million estate has no
other deductions and exemption, a $ 3.5 million exemption means only $ 6.5
million is taxed. The tax of $ 2.95 million (45% of $ 6.5 million) is a tax of
29.5% on the $ 10 million.
As shown in Table 6, the
effective tax averages less than 20% for estates up to $ 20 million and the
average rate on those estates is less than 20%. The effective tax rate also
rises, generally, with estate size, which would be expected as the exemption is
a smaller share of the estate. With the $ 1 million exemption, the tax is 16.5%
in the highest class, while it is 16% under the $ 3.5 million exemption and
11.5% under the $ 5 million exemptions. Important reasons for lower effective
tax rates are the exemption, spousal transfers, and charitable contributions.
The decline in effective tax rate at the very highest estate size for the $ 1
million exemption may reflect the greater likelihood of charitable
contributions and the lesser importance of the exemption.
Table 6. Effective Estate Tax Rate (Tax as
Percentage of Assets), 2011
$ 1 Million $
3.5 Million $ 5
Million
Size of
Exemption,
Exemption,
Exemption,
Estate ($ millions) 55%
Rate
45% Rate,
35% Rate
1-2 2.6
0.0
0.0
2-3.5
10.1
0.0
0.0
3.5-5
12.9
1.5
0.0
5-10
15.5
7.2
2.6
10-20 18.6 13.6
7.9
Over 20
16.5
16.0 11.5
Source:
Based on data in Urban Brookings Tax Policy Center, Tables
T09-0396, T09-0398, T09-0399,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2471&topic2ID=60&topic3ID=66&DocTypeID=
Most distributional analyses of
taxes are reported relative to income. As shown in Table 7, the Tax
Policy Center has estimated the distribution by income class of the tax for the
$ 1 million exemption /55% rate and the $ 3.5 million exemption/45% tax rate.
As this table indicates, the estate tax is highly concentrated in the higher
income classes. For the $ 1 million exemption, 83% of the tax falls in the top
quintile and 45% of the tax in the top 1%. For the $ 3.5 million exemption, 96%
of the tax is imposed on the top quintile and 72% on the top 1%. These results
indicate that the estate tax is a highly progressive feature of the federal tax
system. n9
Table
7. Distribution of Estate Taxes by Income Class
$ 1 Million Exemption,
$ 3.5 Million Exemption,
Income Share
55% Rate
45% Rate
Bottom Quintile
0.3 0.1
Second Quintile
0.9
0.2
Middle Quintile
5.2
0.4
Fourth Quintile
8.9
0.4
Top Quintile
83.1 96.2
80-90th Percentile
8.6
2.0
90-95th Percentile
6.0
1.3
95-99th Percentile
23.4
20.8
Top 1%
45.0 72.0
Top 0.1%
22.6
42.1
Source:
Based on data from Urban Brookings Tax Policy Center, Tables
T10-0073 and T09-0402,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2664&topic2ID=60&topic3ID=66&DocTypeID=
Notes:
Distribution for the $ 1 million exemption is based on combined
data with distributions for 2009
and 2012, weighted by 2010 revenue effects.
Distribution for the $ 3.5
million exemption is for 2009.
Effects on Small Businesses and
Farmers
An issue that has played an
important role in the debate over the estate tax is the possible impact on
small businesses and farms. The role played by the small business issue in the
original 2001 legislation is detailed by Graetz and Shapiro. n10 Arguments were made that the estate
tax causes families to have to sell businesses to pay the estate tax because
there are not enough liquid assets to pay the tax.
According to aggregate data for
2008, farm assets account for 2.4% of assets reported on estate tax returns,
and business assets constitute 17.9%.
n11 These shares include assets of estates where business or farm assets
may be a minor part of the estate.
Evidence on the effect of the tax
on small business suggests that the taxable business estates are a small share
of all taxable estates and a small share of estates of all business decedents. Table
8 provides estimates for the coverage of the estate tax reported or derived
from the Urban Brookings Tax Policy Center of estates with at least half of
their assets in business. As shown in the table, these estates are less than
10% of taxable estates, and, as with other estates, only a small fraction of
business estates pay the estate tax (0.2% for the $ 3.5 million and $ 5 million
exemption).
Table 8.
Coverage of Estates with At Least Half of Assets in
a Business, 2011
Estimated Taxable
Estates
of
Businesses as a
Percentage of all Percentage of
Taxable Estate Taxable Estate
Decedents with
Exemption Returns
Returns
Business Assets
$ 1 million 3030
6.9
1.6
$ 3.5 million
440
6.9
0.2
$ 5 million 350
9.8
0.2
Source:
Based on data from Urban Brookings Tax Policy Center. Data on
Taxable Estates of with Half of
More of the Estate in Business Assets from
Tables T09-0196, T09-0i98, and
T09-0199,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2270&topic2ID=60&topic3ID=66&DocTypeID=.
Data on total number of estates
and total decedents from Table T09-0431,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2506&topic2ID=60&topic3ID=66&DocTypeID=.
Data on the share of tax returns
with at least half of income from business is
from Table T09-0426,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2501&topic2ID=60&topic3ID=73&DocTypeID=.
Notes:
To estimate the share of decedents with business assets, the
share of income tax returns with
more than half of income from small business
(7.5%) was multiplied by the
total number of decedents.
As shown in Table 9, data
indicate that returns with business assets account for a somewhat higher share
of the estate tax than they do of the number of taxable estates, suggesting
some larger concentration of business assets in larger estates. (Note that in
this case, the tax paid reflects total estate tax, and thus includes tax on business
and non-business assets.) However, the effective tax rates (taxes paid as a
percentage of the assets of all estates of $ 1 million or more) are somewhat
lower for these small business returns, suggesting the use of discounts may be
important.
Table 9. Taxes Paid on
Small Business Estates, 2011
Effective Tax
Estate Tax
Share of Rate, Effective Tax
Liability
Estate Tax
Business
Rates, All
Exemption/Rate ($
billions)
Liability
Estates Estates
$ 1 million, 55% 3.7 10.8 10.4
10.8
$ 3.5 million, 45%
2.9
16.0
9.3
10.8
$ 5 million, 35% 1.8
18.0
7.8
8.1
Source:
Based on data from Urban Brookings Tax Policy Center.
Data on Taxable Estates of with
Half of More of the Estate in
Business Assets from Tables
T09-0196, T09-0198, and T09-0199,
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2270&topic2ID=60&topic3ID=66&DocTypeID=.
Although the Urban Brookings Tax
Policy Center did not separately estimate farmer estates or consider questions
of whether these estates had adequate liquid assets to pay the tax, a study
done by the Congressional Budget Office (CBO) did examine these issues. This
CBO study likely defined farmers more broadly than the Tax Policy Center
criterion. At the same time, it examined the subset of estates that took the
QFOBI exemption, which would be both small business and farm estates where the
heirs expected to continue the business and where more than half of the estate
was in the family business. The analysis was for 2000. Column 2 of Table 10
reports those values at an average annual growth rate of 3.5% for 11 years (for
2000 to 2011), to project the distribution across estate sizes for 2011. (This
measure increases the value by the average annual growth rate of the economy minus
growth in the labor force for 2000-2009, applied over 11 years, thus taking
into account real wealth growth as well as inflation.)
Table 10
indicates that the number of farm estates, using their measure of farms subject
to the tax, would be less than 123 estates at the $ 3.5 million exemption and
about 65 at the $ 5 million exemption. These estates are about 2% of all
estates owing tax. The number of returns claiming QFOBI are also small,
accounting for 2% to 2.5% of all taxable estate returns.
Table 10. Number of Farm Estates or Estates
Claiming QFOBI Deductions
with
Estate Tax Liability at Different Exemption Levels
2000 Level
Exemption Adjusted Number of Percentage
Number of Percentage
Level for 2011 ($
Farm of
Total
QFOBI
of Total
($ millions) millions) Estates Estates Estates Estates
0.675 1.0 1659
3.2
485
0.9
1.5
2.2
300
2.2
223 1.6
2.0
3.0
123 1.9
135
2.1
3.5
5.1
65 1.8
94 2.5
Source:
Congressional Budget Office, Effects of the Federal
Estate Tax on Farms and Small
Businesses, July 2005.
http://www.cbo.gov/ftpdocs/65xx/doc6512/07-06-EstateTax.pdf.
Table 11
shows results the study found for a second question: how many estates of these
types are likely to have insufficient liquid assets in the estate to pay the
tax liability? While there were 138 farm estates in these circumstances for the
$ 1 million exemption, there were only about 15 for the larger exemptions.
These returns account for 0.2% and 0.4% of returns paying estate tax. For
estates claiming the QFOBI deduction there were 62 at the $ 3.5 million
exemption and 41 at the $ 5 million exemption. These returns accounted for
about 1% of taxable estates.
Table 11. Number of Farm
Estates or Estates Claiming QFOBI with
Insufficient Liquid Assets to Pay the Tax
Number of
Number of
Level
Farm Estates
QFOBI
2000 Adjusted for with
Percentage Estates
with Percentage
Exemption
2011
Insufficient of Total Insufficient of Total
($ millions) ($ millions) Liquidity Estates Liquidity Estates
0.675 1.0 138 0.3
164
0.3
1.5
2.2 27 0.2
82 0.5
2.0
3.0
15 0.2
62 0.9
3.5
5.1
13 0.4
41 1.1
Source:
Congressional Budget Office, Effects of the Federal
Estate Tax on Farms and Small
Businesses, July 2005,
http://www.cbo.gov/ftpdocs/65xx/doc6512/07-06-EstateTax.pdf.
A different survey of farmers
performed by the Department of Agriculture estimated that farm estates would
pay $ 683 million in estate taxes in 2009, which would be just under 4% of
total estate tax liability, and that 1.6% of farms decedents would pay the
estate tax under the 2009 provisions.
n12 This share is much larger than the share for businesses overall
reported by the Tax Policy Center and is also about twice as large as the
estimates implied by the CBO study.
n13
Regardless of the data source
used, the evidence suggests two important characteristics of businesses and the
estate tax: businesses pay a small fraction of the estate tax and a tiny
fraction of total estates of businesses and farmers are liable for the tax. If
estate tax policy decisions are driven by these concerns, a more
target-efficient alternative would be to provide additional benefits for
business assets, such as an expanded QFOBI deduction. n14
Effects on Savings and Output
Some claims have been made that
the estate tax causes a significant reduction in savings. This effect may be
alleged to be so damaging that it justifies eliminating the tax. However, there
is no clear basis for this claim. Economic theory does not provide a clear
guide. If the bequest motive is primarily to leave a bequest to one's heirs
because of concerns about their welfare, the estate tax could lead to less
saving (because a gift to one's children is made more costly relative to one's
own consumption, the substitution effect), or it could lead to more savings to
retain a larger amount after the estate tax is paid (the income effect). These
offsetting income and substitution effects create an ambiguous theoretical
prediction about the effect of the estate tax on savings. If the main purpose
of accumulating assets is to provide a precautionary savings amount (to account
for catastrophic illness, for example), the estate tax does not matter, since
it is irrelevant to that purpose.
With theoretical uncertainty, the
issue becomes an empirical one. Here, however, there is virtually no empirical
evidence. In the single study of the wealth elasticity of estates (the
percentage change in wealth divided by the percentage change in taxes), Kopczuk
and Slemrod characterized their results as fragile, meaning that the results
depended on model specification.
n15
A study by Holtz-Eakin and Smith
used an elasticity from one of the specifications in the Kopczuk and Slemrod
study to estimate that the estate tax caused a decrease in wealth of $ 1.6
trillion. n16 Although this
estimate was based on total projected wealth associated with those filing
estate tax returns (in 2004), the report indicated the increase in capital was
an increase in small business capital (although, as noted above small
businesses account for only a fraction, about 16%, of the estate tax). That
estimate was, in turn, used to project increases in hiring by small businesses.
The effect projected in the
Holtz-Eakin and Smith study appears quite large. n17 As a simple illustration, consider that the effect of
estate taxes on savings should be similar to the effect of capital income taxes
in general. In 2007, the last year for which data on sources of income in the
income tax were available, the estate tax accounted for only 4% of capital
income tax revenue at the Federal level.
n18 This ratio implies that eliminating capital income taxes would
increase wealth by $ 40 trillion ($ 1.6 trillion dividend by 0.04). This amount
would be an approximate doubling of the total U.S. capital stock. n19 Even the most generous model with
infinitely elastic savings responses tends to produce an increase of about
one-third that size, and estimates based on the higher end of empirically
estimated time-series savings rates would suggest a result only one-tenth of
that size. Some effects from dynamic models, depending on how the revenue loss
is offset, are negative or negligible.
n20
One problem with the estimate in
the estate tax study is that it did not take account of feedback effects from
the economy, particularly the decline in pre-tax return when the capital stock
expands. n21 That feedback effect
is the reason that an infinitely elastic response leads to a limited effect:
the capital stock expands only enough to drive the after tax return back to its
original value.
Given lack of theoretical and
empirical evidence it is not possible to precisely determine what the effect of
repealing the estate tax on savings, but it is likely to be small, simply
because the yield of the tax is small. Any effect on the stock of capital in
small business should only be a fraction of that amount.
The tax rate is more important
than the exemption in determining any positive effects of reducing the estate
tax on savings, since that rate is more important for the marginal rate that
drives the substitution effect. Exemptions affect the substitution effect by
pushing some income into a zero marginal tax rate, but are more important for
the average rates that determine the income effect, so that higher exemptions
are less likely to increase savings than higher rates.
Effect on Charitable
Contributions
Unlike the effect of the estate
tax on savings, there is an extensive empirical literature on the response of
charitable bequests in the estate tax, and the evidence indicates a significant
response of bequests. Nevertheless, according to a recent CRS study, the effect
on overall charitable giving is likely to be small: moving from the $ 1 million
exemption with a 55% tax rate to the $ 3.5 million exemption with a 45% tax
rate would be projected to lower charitable giving by 1%; moving to the $ 5
million exemption with a 35% rate would be projected to reduce giving by
2%. n22 These relatively small
effects occur largely because only 4% to 6% of giving is affected by the estate
tax. The effects would be larger for foundations and certain types of
organizations (such as higher education) that are more likely to receive
bequests.
Administrative and Compliance
Cost
Another issue is the degree to
which the estate tax causes excessive compliance and planning costs for
taxpayers, and administrative costs for the IRS. Some arguments have been made
that these costs, particularly for estate planning, are as large as the estate
tax itself. Gale and Slemrod, however, review the limited evidence and conclude
that the cost of administration and compliance is probably in the neighborhood
of 7% of revenues, with almost all of that cost due to planning and
compliance. n23
Other Design Issues
This section briefly discusses
proposals to revise certain features of the estate tax. These include
portability of the spousal exemption, changing the rules on certain trusts,
restricting minority discounts, and conforming definitions of fair market value
for estates and heirs. n24
Portability of the Spousal
Exemption
Because transfers between spouses
are exempt from the estate tax, the estate exemption is of no value to a person
who transfers all of his or her estate to a spouse. For example, if the estate
tax exemption is $ 3.5 million and a couple jointly owns assets of $ 8 million
($ 4 million each), if the first spouse to die leaves $ 4 million to the second
spouse, and the second spouse then leaves $ 8 million to children, $ 4.5
million of the estate will be subject to tax. If the first spouse to die left $
3.5 million to the children directly, then the second spouse would have an
estate of $ 4.5 million, with only $ 1 million subject to the estate tax.
There are estate planning options
(such as credit shelter trusts) that can address this issue. However, these
options (which may also require an initial transfer of assets between spouses)
not only require complicated estate tax planning but also may cause taxpayers
to dispose of their assets in a way that they would not prefer.
Simply allowing a spouse to
inherit any unused portion of the exemption is an alternative. In the example
above, all of the assets could be left to the remaining spouse on the death of
the first spouse, and the second spouse to die would be able to claim a total
exemption of $ 7 million (the sum of both exemptions). Portability can also be
valuable with assets, such as pension rights, that cannot be transferred.
Although there are some
advantages to this provision in both equity and simplified planning, there are
problems as well. First, the portability provision will cost increasing amounts
of revenue in the future. The JCT provided estimates suggesting that the number
of estates benefitting from portability will increase by 14 times over 10
years. n25 Thus, allowing
portability is likely to substantially decrease revenues in the long run.
However, it may be more likely to benefit smaller estates where it may be more
difficult to engage in the types of transfers and planning needed to absorb the
credits.
There are some complications as
well for designing and administering this provision, some of which are detailed
in the JCT study. n26 Second (and
more) marriages raise an issue. Should the inheritance be allowed for future
marriages or should it be inherited only once? That is, suppose a widow
remarries, and then dies leaving all her assets to a second spouse: does the
second spouse inherit two exemptions or one? Is there a possibility for
deathbed marriages to terminally ill low income individuals to generate an
additional deduction (and how can that be distinguished from
"legitimate" marriages with a tragic early death)?
Another question is: should the
value of the inherited exemption be limited to the value of the spouse's
estate? That seems to be a reasonable rule. Otherwise, if the second spouse
continues to accumulate wealth, the portability would effectively increase the
exemption over the amount available had each spouse absorbed the exemption in
their own estate. Such a rule, however, would require the filing of estate tax
returns and valuation of the estate when they would not otherwise be subject to
tax. There would also be issues about how to reconstruct fair market value, if
the portability were allowed if the first estate tax return were not filed. As
with many solutions that seem simple, complications remain.
Grantor Retained Annuity Trusts
A Grantor Retained Annuity Trust
(GRAT) is a trust that allows the grantor to receive an annuity, with any
remaining assets transferred to the trust recipient. The value of the gift is
reduced by the value of the assets used to fund the annuity. If the assets in
the trust appreciate substantially, then virtually all of the gift can be
reduced by the value of the annuity, while still providing a substantial
ultimate gift to the recipient. If the grantor dies during the annuity period
the remaining value of the annuity is included in the estate. Thus for this
trust approach to be a method of transferring assets roughly tax free, the
assets must appreciate at a rate faster than the discount rate used to value
the annuity, and the grantor needs to survive over the period of the annuity.
To assure the latter will be likely to occur, many of these trusts have very
short annuity periods, as short as two years. The GRAT proposal contained in
H.R. 4849 and in the President's budget proposals n27 would impose a minimum annuity term of 10 years,
disallow any decline in the annuity, and require a non-zero remainder interest.
The Administration estimates this proposal would raise $ 3 billion over 10
years.
Minority Discounts
There are existing restrictions
to keep estates from engaging in artificial actions designed to reduce the
value of estates (such as freezes on assets). As discussed above, courts
sometimes allow estates to reduce the fair market value when assets are left in
family partnerships where no one has a majority control. These discounts have
even been allowed when assets are in cash and readily marketable securities,
and the setting up of these family partnerships has become an estate tax
avoidance tool. A provision in the Administration's proposal would set up a
category of disregarded actions that could not be used to allow discounts. The
estimated revenue gain is $ 18.7 billion over 10 years.
Consistent Valuation
There is no explicit rule
preventing a low valuation of fair market value for an estate and a high
valuation of the asset for purposes of stepped up basis in the hands of the
heir. A provision in the Administration's budget proposals would require this
value to be the same and is projected to raise $ 3 billion over 10 years.
Conclusion
The analysis indicates that the
estate tax is relatively small, in revenues, in coverage, and in its effects on
family businesses, savings, charitable contributions, and tax administration
and compliance. One-fourth of 1% or less of all estates and of family
businesses are expected to be subject to tax under an exemption of $ 3.5
million or $ 5 million. This share would grow slightly over the 10-year budget
horizon, but indexing the exemption would not be very important over this short
time period.
The estate tax is a small, but
highly progressive, element of the tax system. Under the proposals under
consideration (the $ 3.5 million exemption and the $ 5 million exemption), the
majority of the tax falls on estates of $ 20 million or more, which in turn
constitute only three-hundredths of 1% of decedents. For the $ 3.5 million
exemption, 45% rate effective in 2009 and under consideration as a permanent
treatment, 96% of the tax falls on the top quintile of the income distribution,
72% falls in the top 1%, and 42% in the top 0.1%.
Effects on savings are uncertain
in direction but likely small. Based on empirical evidence, a decline of 1% to
2% in charitable contributions from increasing the estate tax relative to the
current law baseline of a $ 1 million exemption with a 55% rate would be expected.
Costs of estate planning and administration are relatively small as a
percentage of estate tax revenue.
Because transfers between spouses
are exempt, allowing spouses to inherit the exemption can increase the combined
couples' exemption, and simplify estate planning. This change could cost
increasing amounts of revenue over time, however, and lead to certain
administrative complications.
Several provisions to deal with
perceived abuses might be considered, with the most important one relating to
the use of discounts when assets are left to a family partnership and no one
heir controls the property.
Author Contact Information
Jane G. Gravelle
Senior Specialist in Economic Policy
jgravelle@crs.loc.gov, 7-7829
FOOTNOTES:
n1
See Chuck O'Toole, "Estate Tax Expiration Imminent After
Congress Fails to Complete Action," Tax Notes Today, December 17,
2009, 2009TNT 240-4. For a discussion indicating that there would not be
a legal issue with a retroactive tax, see Jay Starkman, "Can an Estate Tax
be Retroactive?" Tax Notes, February 22, 2010, pp. 972-974.
n2
In addition to H.R. 4154, numerous bills have been introduced
in the 111th Congress to address the estate tax. See CRS Report R40964, Estate
Tax Legislation in the 111th Congress, by Nonna A. The phase-in proposal
was described in Martin Vaughn, U.S. Effort to Reduce Estate Tax Hits
Turbulance, Dow Jones Newswire, May 18, 2010, posted at
http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201005181832dowjonesdjonline000463&title=us-senate-effort-to-reduce-estate-tax-hits-turbulence.
n3
CRS Report 95-416, Federal Estate, Gift, and
Generation-Skipping Taxes: A Description of Current Law, by John R. Luckey
provides a detailed description of the estate tax.
n4
For example, parents may directly skip a generation by
leaving some assets to grandchildren, or they may set up a lifetime trust for
their children, with the assets subsequently inherited by the grandchildren.
The generation skipping tax is imposed in these circumstances, although it also
has an exemption.
n5
To convert the statutory tax inclusive rate into an
equivalent rate for a tax exclusive application, the formula is t/(1+t), where
t is the tax inclusive rate.
n6
Leaders of both parties have indicated an intention to
continue an estate tax, although some bills propose its permanent elimination.
If the estate tax is eliminated, the main options are whether or not to continue
the gift tax and the carryover basis for appreciated assets. In the absence of
an estate tax, a gift tax can limit certain abuses that can arise from the
transfer of assets between taxpayers with differing tax rates. These issues are
not discussed in detail in this report.
n7
William G. Gale and Joel Slemrod, "Rhetoric and
Economics in the Estate Tax Debate," National Tax Journal, vol. 54,
September 2001, pp. 613-627.
n8
These Treasury and JCT numbers are reported on a year-by-year
basis in CRS Report R40964, Estate Tax Legislation in the 111th Congress,
by Nonna A. Noto.
n9
The corporate tax is estimated to have a similar amount of
concentration at higher income levels as the estate tax at the $ 1 million
exemption level; the $ 3.5 million level is more concentrated. The individual
income tax is more progressive at the lower end of the distribution, however,
because it provides subsidies. For comparisons of taxes see Urban Brooking Tax
Policy Center Table T09-0373
http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=2448&topic2ID=40&topic3ID=81&DocTypeID=.
n10
Michael J. Graetz and Ian Shapiro, Death by a Thousand
Cuts: The Fight Over Taxing Inherited Wealth, Princeton, N.J. Princeton
University Press, 2005.
n11
See CRS Report RS20593, Asset Distribution of Taxable
Estates: An Analysis, by Steven Maguire. Assets counted as business include
closely held stock , real estate partnerships, other limited partnerships, farm
assets, and other noncorporate business assets. If real estate and limited
partnerships are excluded, the share is 14%.
n12
Ron Durst, Federal Tax Policies and Farm Households,
U.S. Department of Agriculture, Economic Information Bulletin 54, Mau 2009,
http://www.ers.usda.gov/Publications/EIB54/EIB54.pdf.
n13
The number of farms reported in the USDA study are 2.022
million, and if the average death to population ratio (about 0.008) were
applied, the number of total farm decedents would be about 17,000. The 123
returns reported by CBO are about 0.7% of this number.
n14
See CRS Report RL33070, Estate Taxes and Family
Businesses: Economic Issues, by Jane G. Gravelle and Steven Maguire for a
discussion of business deduction options.
n15
Wojciech Kopczuk and Joel Slemrod, "The Impact of the
Estate Tax on the Wealth Accumulation and Avoidance Behavior of Donors,"
Working Paper 7960, National Bureau of Economic Research, October 2000.
n16
Douglas Holtz-Eakin and Cameron T. Smith. "Changing
Views of the Estate Tax: Implications for Legislative Options," American
Family Business Foundation, February 2009.
n17
Unfortunately, the study did not spell out the methodology
used in detail, including not identifying precisely what elasticity was used or
how the price and income effects were measured.
n18
Based on CBO data the estate tax collected $ 26 billion in
that year, while the corporate tax collected $ 370 billion and capital gains $
126 billion (Congressional Budget Office, The Budget and Economic Outlook for
FY2010-FY2019, January 2010,
http://www.cbo.gov/ftpdocs/108xx/doc10871/01-26-Outlook.pdf). From individual
tax return data an additional $ 121 billion is estimated from the individual
income tax (a 15% tax on qualified dividends, a 20% tax on other income
including interest, rent, and business income). The estimate assumes that 25%
of business income is a return to capital. Data from Internal Revenue Service,
Statistics of Income, Individual Income Tax Returns, located at
http://www.irs.gov/taxstats/.
n19
Based on a typical rule of thumb that the capital stock is
3.5 times output, the capital stock would be around $ 40 billion. Note that a
different functional form, such as a constant elasticity function, could alter
the projection but not the general magnitude.
n20
See Eric Engen, Jane Gravelle, and Kent Smetters,
"Dynamic Tax Models: Why They Do the Things They Do" National Tax
Journal , vol. 50, September 1997, pp. 657-682. Results from eliminating
capital income taxes ranged from a 1% fall in the capital stock to a 34% rise.
n21
In technical terms, the estimate appears to have been made
solely from looking at the supply curve and did not take account of the demand
curve. The elasticity of the demand curve for capital with respect to the rate
of return is the factor substitution elasticity divided by the labor income
share of output, and multiplied by the rate of return, divided by the rate of
return plus depreciation. The factor substitution elasticity is generally one
or less in absolute value (the elasticity is negative), the labor share about
two-thirds, and the ratio of return to return plus depreciation about 0.7
making the absolute value of the demand elasticity of capital 1.05 or less.
Since the total elasticity is the demand elasticity times the supply
elasticity, all divided by the sum of the absolute value of the two
elasticities, and the calculations imply that the supply elasticity is about
2.22, the inclusion of demand effects would have reduced the projection by over
two-thirds.
n22
CRS Report R40518, Charitable Contributions: The Itemized
Deduction Cap and Other FY2011 Budget Options, by Jane G. Gravelle and
Donald J. Marples.
n23
William G. Gale and Joel Slemrod, "Rhetoric and
Economics in the Estate Tax Debate," National Tax Journal, vol. 54,
September 2001, pp. 613-627.
n24
These issues do not exhaust the possible reforms that might
be considered. See CRS Report RL30600, Estate and Gift Taxes: Economic
Issues, by Donald J. Marples and Jane G. Gravelle, pp. 22-24.
n25
Joint Committee on Taxation, Taxation of Wealth Transfers
Within A Family: A Discussion of Selected Areas for Possible Reform,
JCX-23-08, http://www.jct.gov/publications.html?func=startdown&id=1317.
n26
See also William J. Turnier, "Three Equitable
Taxpayer-Friendly Reforms of Estate and Gift Taxation," Tax Notes,
April 10, 2000, pp. 269-279.
n27
For a discussion of these and other proposals, see the "Green Book": General Explanations of the Administrations Fiscal Year 2011 Revenue Proposals, February 2010, http://www.treas.gov/offices/tax-policy/library/greenbk10.pdf
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