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REPUBLICANSTAFFSTUDY

CostandConsequencesoftheFederalEstateTaxAnUpdateJuly25,2012ExecutiveSummaryThisstudyconfirmsthatthecostoftheestatetaxfarexceedsanybenefitsitproduces. This study updates and extends two previous Joint EconomicCommittee studieson theestate tax, buildingon theseprevious studies toreflectupdateddataandlegislation.

The estate tax has reduced the amount of capital stock in theeconomyasdescribedinpreviousJointEconomicCommitteestudiesin 19981 and 2006.2 As of 2008, the estate tax has cumulativelyreducedtheamountofcapitalstockintheU.S.economybyroughly$1.1 trillion since its introduction as a permanent tax in 1916,equivalentto3.2percentofthetotalcapitalstock.

Theestatetaxisanoverwhelmingcauseofthedissolutionoffamilybusinesses. The estate tax is a significant hindrance toentrepreneurial activity because many family businesses lacksufficientliquidassetstopayestatetaxliabilities.

The estate tax does not reduce income and wealth inequality.Perversely, the estate tax creates a barrier to income and wealthmobility.

Economicinefficienciesduetothedistortionaryeffectsoftheestate

taxareburdensome,andthecostsofcomplianceassociatedwiththeestatetaxaddtothepaperworkandtimenecessarytocomplywithothertaxes.

The estate tax raises a negligible amount of revenue. Since its

inceptionnearly100yearsago, theestatetaxhasraised justunder$1.3trillionintotalrevenue;bycomparison,thatisequivalenttotheU.S.federaldeficitforfiscalyear2011alone.

Many studies have indicated that abolition of the estate taxwould

actuallyincreaseoverallfederaltaxrevenueinatleasttwoways:(1)the estate tax robs additional federal tax revenues from thecollection of other taxes like the income tax, and (2) a larger totalcapitalstockcouldincreaseincometaxrevenue.

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Contents

INTRODUCTION2

OVERVIEWOFTHEFEDERALESTATETAX......................................2HistoricalandCurrentTaxRates...................................................3TaxableEstates..............................5InternationalComparisons........5

ARGUMENTSFORESTATETAXATIONAREWEAK...................6FederalRevenue............................6EstateTaxandInequality...........7IntergenerationalTransfersandWealthDistribution......................9WealthandIncomeMobility10EstateTaxandCharitableContributions................................13

ARGUMENTSAGAINSTESTATETAXATION.......................................15EstateTaxReducesSavings,IncreasesConsumption.............15ReductionintheCapitalStockoftheEconomy..................................16TheEstateTaxRemainsaBurdentoFamilyBusiness......18

CONCLUSION.................................18

APPENDIX.......................................20EstateandGiftTaxRevenue,19162010......................................20TableofEstateTaxRatesBefore,During,andAfterEGTRRA,19162007......................................21

REFERENCES..................................22

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Theartoftaxationconsistsinsopluckingthegooseastogetthemostfeatherswiththeleasthissing.

JeanBaptisteColbert,MinisterofFinancetoLouisXIVofFranceIntroductionAsalludedtobyJeanBaptisteColbert,effectivetaxationrequiresefficiencyto achieve the greatest amount of revenue, but at the least distortion ofoutput,employment,andgrowth.Andyet,theestatetaxfailsonbothcounts.The commentary will first review the federal estate tax and structure,examininghistoricaldataontheestateandgifttax,exemptions,andtaxableestates. Following that discussion, the focus will turn to addressing thecommonargumentsfortheestatetaxthatarenotvalid,particularlydelvinginto types of economic inequality that the estate tax exacerbates and itsadverse impact on wealth and income mobility. Prior to concluding, thecommentary will shift to arguments against estate taxation, detailing theeffectsoftheestatetaxonsavingsandconsumption,thecapitalstockoftheeconomy,anditsburdentofamilybusinesses.OverviewoftheFederalEstateTaxAccordingtotheInternalRevenueService(IRS),theestatetaxisataxonanindividualsrighttotransferpropertyathisorherdeath.Congressenactedtemporaryestatetaxestofinancemilitaryactivities(17971802,18621870,and18981902).In1916,Congressmadetheestatetaxapermanentpartofthe federal tax system. Through the Tax Reform Act of 1976, Congressreshapedtheestatetaxintoitscurrentformthatprovidesaunifiedsystemtotaxalltypesofwealthtransfers.Thecurrent formof the federalestate tax includes: (1)a traditionalestatetax,(2)agifttax,and(3)agenerationskippingtransfer(GST)tax.Therearethreemajorestatetaxcreditsthatprovideadollarfordollaroffsetagainstanestatesfederalestatetaxliability:(1)theunifiedtransfercredit,(2)thecreditforforeigndeathtaxes,and(3)thecreditforfederalestatetaxespaidbypreviousestates.Being cumulative in nature, the gift tax requires that all giftsmadeby thedecedentduringhisorherlifebeincludedinthevalueoftheestatefortaxpurposes. Atpresent,everydonormayexcludethe first$13,000($26,000per recipient from married couples) of cash or property given to eachrecipientannually.Firstenactedin1976andmodifiedbytheTaxReformActof1986,theGSTisimposedonoutrightgiftsandtransfersintrustforthebenefitofindividualstwoormoregenerationsyoungerthanthedecedent. TheGSTisaflatratetaxsetatthetopestatetaxrate,35percentasof2012,witha$5.12millionexemption(indexedforinflationperindividualwhilelivingoratdeathanddoubledformarriedcouples).3Theestatetaxisintendedasatoolofredistribution,butgeneratestheleastamountoffederalrevenueofanysource,yieldingverylittletoredistribute.Rather,iftheestatetaxwereabolished,agreatmajorityoftransferswouldstillbesubjecttocapitalgainstaxationwhenassetsaresold,whichwouldinpartoffsetrevenuelossfromabolishmentoftheestatetax.4

Effectivetaxationrequiresefficiencytoachievethegreatestamountofrevenue,butattheleastdistortionofoutput,employment,andgrowth.Andyet,theestatetaxfailsonbothcounts.Theestatetaxisintendedasatoolofredistribution,butgeneratestheleastamountoffederalrevenueofanysource,yieldingverylittletoredistribute.

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HistoricalandCurrentTaxRatesOver the past decade,the top estate tax rateand the size of theestate subject to taxhave varied. TheEconomic Growth andTax ReliefReconciliation Act of2001 (EGTRRA)gradually reduced thefederal estate taxthrough 2009 andabolishedit in2010asshowninTable1.Under EGTRRA, theestate tax would havebeen reinstatedwith atoprateof55percentplusafivepercentsurtaxontaxableestatesof$10.0millionto$17.2millionin2011.5However,CongressenactedTheTaxRelief,UnemploymentInsuranceReauthorization,andJobCreationActof2010(TRA2010) that replaced the full reinstatement of the estate tax and its preEGTRRArateswithatwoyearreinstatementoftheestatetaxwith(1)a$5millionunifiedandindexedexemptionamount,(2)a35percentmaximumrate,(3)portabilityoftheexemptionamount,and(4)theoptionofapplyingEGTRRAtotheestatesofdecedentsin2010.6Decedentswhopassedawaybefore 2010, but whose estates did not file returns until fiscal year 2010comprisedthepaymentsin2010.7As shown in Table 1 above, the exemption amount for the estate tax hasbeenincreasedfrom$675,000in2001to$5millionin2011and2012.TheGSTtaxexemptionamounthasbeenraisedfrom$1.06millionin2001to$5million in 2011 and $5.12 million in 2012 as well. For gifts, the annualexclusionamounthasbeenadjustedforinflationsince2001andis$13,000in2012.i UnlessCongress acts to change the law, theestate tax rateswillrevertback to theirpreEGTRRA2001 levelsand theestate taxexemptionwillreturnto$1millionin2013.ii,8

i Note: For additional information on the historical detail of estate and gift taxrevenue,aswellas theestate tax including the initial taxrateand topbrackets indollarvalues,seetheAppendix.ii In all, the provisions scheduled to expire December 31, 2012 include (1) thereduction inmaximumestateandgift taxratesto35percent;(2)modificationstoreflect differences in credits resulting fromdifferent tax rates; (3) the increase ofestateandgifttaxexemptionto$5million;(4)portabilityrulesforthesurvivingspousetouseunusedexemptions;(5)thedeductionforstatedeathtaxespaid;(6)expansionandclarificationofestatetaxconservationeasementrules;(7)repealofthequalifiedfamilyownedbusinessdeduction;(8)modificationstothegenerationskipping transfer tax rule for certain transfers to trusts; and (9)modifications toestatetaxinstallmentpaymentrules.

EGTRRAgraduallyreducedthefederalestatetaxthrough2009andabolisheditin2010.UnlessCongressactstochangethelaw,theestatetaxrateswillrevertbacktotheirpreEGTRRA2001levelsandtheestatetaxexemptionwillreturnto$1millionin2013.

Table 1 As a result of EGTRRA, the top estate and gifttax rates declined over time from 2001 to 2010 while theestate, gift, and GST tax exemptions increased. Ratesare expected to return to pre-EGTRRA levels in 2013.

2001 60%* $675,000 $1,060,000 $10,0002002 50% $1,000,000 $1,100,000 $11,0002003 49% $1,000,000 $1,120,000 $11,0002004 48% $1,500,000 $1,500,000 $11,0002005 47% $1,500,000 $1,500,000 $11,0002006 46% $2,000,000 $2,000,000 $12,0002007 45% $2,000,000 $2,000,000 $12,0002008 45% $2,000,000 $2,000,000 $12,0002009 45% $3,500,000 $3,500,000 $13,0002010 $13,0002011 35% $5,000,000 $5,000,000 $13,0002012 35% $5,000,000 $5,120,000 $13,000

2013&later 60%* $1,000,000 $1,360,000 $13,000*Toprateis55%&a 5%surtaxfortaxableestatesof$10.0millionto$17.2million.

EstateandGSTTaxes Repealed

Table1GiftTaxExclusion

GSTTaxExemption

EstateTaxExemption

FiscalYear TopEstate&GiftTaxRates

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According to the IRS, thenumberof estate tax returns filedhasdecreasedsteadilyfrom108,000in2001tofewerthan34,000in2009,primarilydueto increases in the filing threshold. I