Tax Analysts Blog

So Much for the Estate Tax Compromise

Posted on Sep 12, 2016

The estate and gift tax has a long history in the United States. The current version celebrated its 100th birthday on September 8, but there were legacy tax experiments throughout the 19th century. The tax was relatively stable for most of its first 80 years, until Republicans made its repeal one of their central tenets and succeeded in labeling it the death tax. The battle seemed to climax in late 2012, when the American Taxpayer Relief Act (ATRA) permanently extended a compromise version. However, both 2016 presidential candidates would revisit the ATRA solution, albeit in radically different ways.

President George W. Bush thought he had killed the estate tax in 2001. And in fact, the tax did disappear for one year (2010) before reappearing as a result of Senate compromise in 2011. The 2010 bill created a rate of 35 percent and an individual exemption amount of $5 million ($10 million for couples). It was the tax's lowest rate since 1932. President Obama accepted the 2010 compromise, but then campaigned on strengthening the tax in 2012. When he defeated Mitt Romney, his hand was strong enough to force Republicans in Congress to accept the ATRA compromise, which restored the rate to 40 percent while keeping the $5 million threshold. ATRA discarded the silly sunset dates of the 2001 and 2010 laws and purported to be a permanent solution to more than a decade of estate tax uncertainty.

It failed. Republicans remain just as determined to repeal the tax today as they were in 2001. Donald Trump, who doesn't exactly embrace all points of GOP orthodoxy, has estate tax repeal as a part of his platform. According to the Republican nominee, "The estate tax has been a disaster; it's double taxation."  Those words could have been said by virtually any conservative nominee.

Democratic nominee Hillary Clinton has a different idea. She isn't satisfied with Obama's compromise either and, taking a page out of Bernie Sanders's playbook, wants to raise the tax. This fits very well with her general tax position of seeking more revenue from the wealthy. Clinton would raise the rate to 45 percent and set the threshold at $3.5 million for individuals ($7 million for couples). This isn't all that daring of a proposal. It's basically what the tax was in 2009, the year before it disappeared. Sanders's plan would have created a series of rates ranging between 45 and 65 percent, while using the same threshold amounts as Clinton's.

So Republicans want to repeal the tax while Democrats would like to roll it back to essentially 2009 levels. While these positions seem diametrically opposed, it's important to note how modest the Democrats' plans (even Sanders's) are. In 2001 the exclusion amount was a mere $675,000, while the top rate was 55 percent. In 1977 the tax was 77 percent of estates over $10 million. So Democrats have shifted quite a bit to the right on this issue since the Carter administration. The Republicans have been very successful in driving the estate tax agenda in the United States, and have sharply scaled the levy back while at the same time attracting significant Democratic support for less taxes on inherited wealth.

Uncertainty in estate tax planning was a hallmark of the period from 2009 to 2012, when the tax was scheduled to expire, did expire, and then was brought back with another sunset provision.  ATRA was designed to eliminate that uncertainty, but it has not decided the issue. While it remains to be seen how committed either Trump or Clinton are to actual estate tax reform, it is clear that both parties will continue to campaign as though the estate tax issue is far from settled.

Read Comments (4)

Edmund DantesSep 12, 2016

Back when the exclusion was only $675,000, that meant most homeowners on both coasts were subject to the federal estate tax. That was way, way too many affected families. Imposing taxes at death is a repellant idea, it only works if you can keep the number affected down to 1% or so of the population.

Many prominent Democrats switched sides on the estate tax when evidence rolled in about how destructive it was to family business. Frank Blethen made the case very eloquently, as he explained how the estate tax forced the consolidation of the newspaper industry--it just wasn't financially feasible to keep a newspaper in the family (with the apparent exception of the NYTimes). People seem to think that fortunes consist of cash, so that paying 40% of the value of a business to the IRS in 9 months is no big deal. Fortunes rarely include that much cash. Saddling any business with a massive estate tax debt will cripple it compared to its competitors who have no comparable burden. Then they go out of business.

The problem with focusing the estate tax on the top 1% is that not enough of them die every year, so there's not enough revenue generated. The cost of administering the estate tax is very high compared to tax collected. And it is really complicated--see, for example the current controversy over IRS regs. outlawing minority discounts for business interests transferred to family members. Regs. that are specifically intended to end continuing a family business in the family (minority discounts are fine for sales to outsiders).

Fundamentally, we only keep the federal estate tax to keep the life insurance companies happy, as well as the accountants and lawyers who provide expensive services in this area. Plenty of studies show that the economy would grow faster and we'd have more jobs--generating more income taxes--if we dropped the estate tax completely. One of these studies came from the Congress.

Hence the continued Republican support for repeal. It shouldn't be surprising. BTW, Republicans didn't invent the term "death tax," it's been in the tax code for decades to refer to states' inheritance and estate taxes. Republicans only popularized it, making the tax more concrete and understandable. Once understood, most people hate the idea.

Mike55Sep 12, 2016

"While it remains to be seen how committed either Trump or Clinton are to actual estate tax reform, it is clear that both parties will continue to campaign as though the estate tax issue is far from settled."

Neither is committed to reform: one candidate wants to tweak exemptions/rates in order to collect additional revenue, while the other wants to eliminate the tax entirely. Whether one views those as good ideas or bad ideas, neither fits into the definition of "reform."

And I for one think that's too bad. The estate tax has a lot of potential but, as Edmund Dantes points out above, the current version is in pretty sad shape. It'd be interesting to see what a well designed estate tax actually looks like before we decide whether or not we ought to have one. I'd be willing to bet Republicans would be less upset about the "death tax" if it applied in a more intuitive fashion than what we have today.

Edmund DantesSep 13, 2016

Excellent points by Mike 55. A better estate tax would be one with a tax rate of only 10%, reducing the stakes and the need for such massive amounts of life insurance to provide liquidity and fancy strategies for tax avoidance. A still better death tax, in my view, would be to eliminate transfer taxes but treat death as a realization event, and apply the capital gains tax to all built up gains. Folding the death tax into the existing income tax system would be an intuitive and understandable simplification.

d profittSep 24, 2016

Edmund, the idea of having the estate tax be a realization event for income tax purposes is attractive. The rates would be the same as income tax rates so that would remove a tax avoidance opportunity that simply repealing the estate tax would leave. Would you apply that to all estates or just those over some threshold. Also would the tax be applied at the estate level or the beneficiary level? And how might that work with joint property or property disposed of by contract, such as retirement plans and life insurance.

Another issue would be valuation of property passed at death which is not liquidated. Of course that exists under current law. And there probably should be some way to defer the liability as exists in the current estate tax code for certain property, such as businesses. Otherwise it could still force a liquidation.

If there were no exemptions or thresholds this would amount to a great expansion of the estate tax.

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