Tax Analysts Blog

The Unpopular Tax That Almost No One Pays

Posted on Feb 22, 2017

Since the 1970s, Republicans have successfully turned the United States into an antitax country. Voters and the public are wary of any new levy, largely believe that any tax cut is by definition good, and don't trust the government to wisely spend what taxes it does collect. Nowhere has this been more successful than in the transformation of the estate tax into the so-called death tax. The estate tax now faces near certain extinction even though almost no one pays it, and very few even face the prospect of paying it.

When President Clinton left office, the estate tax rate was 55 percent and the total exemption was $675,000. With control of the White House and Congress in the wake of George W. Bush's victory, Republicans went on the offensive. As part of his 2001 tax cuts, Bush pushed for complete repeal of the estate tax, arguing, as the GOP had done for years, that it damaged family farms, double-taxed earnings, and forced the breakup of small businesses. Bush and Republicans were successful, to a point. The estate tax was phased out over 10 years, but because of budget rules, it would return in 2011 absent new legislation. From 2001 to 2009, the exemption rose to $3.5 million and the rate dropped to 45 percent. As part of a complicated compromise after the estate tax disappeared, the exemption was $5 million in 2010, 2011, and 2012, and the rate was 35 percent. After his victory in 2012, President Obama refused to allow the rate to stay at 35 percent, so the American Taxpayer Relief Act of 2012 indexed the exemption to inflation and gave the estate tax a new rate of 40 percent. It was a small, and perhaps final, victory for a progressive inheritance tax.

The exemption for 2016 is $5.45 million for an individual. It doubles for a married couple, and a surviving spouse can keep a decedent's exemption (portability). That means the only people who would pay the estate tax are multimillionaires who are either exceptionally rich or have done virtually no estate planning. In 2013, out of 2.6 million deaths, only 4,700 returns were filed showing estate tax liability. That's 0.2 percent of the population of decedents.  And despite a top rate of 40 percent, the Urban-Brookings Tax Policy Center says those returns averaged an effective tax rate of about 17 percent.

Given that almost no one pays the tax, why is it so unpopular? There are a number of reasons, of which sympathy for family farms is only one. Many Americans have very aspirational (some might say unrealistic) views of what their wealth will be at the end of their lives and resent the idea that they might pay the tax, even if the chances of it are small. Some economists and policymakers oppose yet another form of double taxation in the code (the corporate income tax being the prime example). And, of course, the estate tax disproportionately affects households that are likely to include large donors to political campaigns and lobbying firms.  

But maybe the main reason the tax is so unpopular is that politicians in both parties can afford to rail against it. The tax only raises about $25 billion a year, less than 1 percent of total federal revenues. Repealing it would be relatively painless, which allows lawmakers to deliver an easy win to their donors and to a public that doesn't really care about the tax.

With President Trump in the White House and Republicans again in control of both the Senate and the House, the estate tax faces near certain repeal in the next two years. For those who care about progressive taxation, this will be regrettable. But if it is coupled with a repeal of stepped-up basis (which is very likely), perhaps the end result might be a tax system that isn't really much less progressive.    

 

Read Comments (3)

Mike55Feb 22, 2017

Great article. I'd never considered lack of revenue as a reason the estate tax is so unpopular but, after reading your piece, it does make a lot of sense. If the estate tax doesn't move the needle on the Gini coefficient or raise enough money to support meaningful government programs, then what's the point?

I'll add that the estate tax is unpopular because it's bad tax policy, perhaps the worst we currently have, failing our baseline expectation of horizontal equity. Voters demand fair/just laws even when not directly impacted,* so the estate tax will eventually be changed. My own preference would be estate tax reform (there is certainly a role for a wealth tax triggered by death) but, if no one is willing to take on that monumental task, I guess repeal is the next best choice available.

*A few examples: many people are against the death penalty despite that they are more likely to be struck by lightning than executed; many people are pro-choice despite being biologically incapable of becoming pregnant (due to either age or gender); many people were against the recent executive order travel ban despite not hailing from one of the seven countries at issue; many people were against a notorious North Carolina bathroom law that, based upon the best available quantitative analysis, would have impacted approximately zero people. This is just top of mind so I'm sure several of these examples are inapposite, but hopefully the underlying point comes across: people care about issues even when they have no personal stake.

Edmund DantesFeb 23, 2017

Good points all, and I'd like to add these observations:

Death taxes are unpopular not because individuals overestimate the exposure of their own estates, but because a much larger number of people hope to become beneficiaries of those estates. The true impact has never been the number of estates that have to pay the tax, as noted by Mr. Scott, it's the number of beneficiaries whose inheritance has been reduced, perhaps a ten times larger number.

The greatest support for death taxes comes from the life insurance industry. The higher the tax, the more insurance they sell, especially jumbo policies that are really just savings plans to provide liquidity for the death tax payments.

Next greatest support for death taxes comes from those who want to buy businesses and farms at distress sale prices. Not a social good.

Proponents of the death tax like to say that it hits very few family farms, based on IRS statistics. But what they ignore is that most family farms are sold before death, as part of an estate plan in response to the prospective death tax. The massive consolidation in agriculture is due to many things, and one element has been the federal estate tax. There were five farmers in my extended family two generations ago, and now there are none. Only one farm of those five has not been sold to outsiders.

Consolidation in the newspaper industry has also been driven by death taxes, according to Frank Blethen, publisher of the Seattle Times. He thinks this is a bad thing, and I agree.

Finally, Republicans did not invent the phrase "death taxes." It came from the Internal Revenue Code, which for decades used the shorthand "credit for state death taxes" to conveniently group estate and inheritance taxes. However, Republicans did popularize the term. Legitimately and honestly, as those are taxes triggered by death, and only by death, so the term is fair. Republicans were just using language that everyone understands. That's a good thing.

Bob GoulderFeb 23, 2017

Nice post, Jeremy. I'm glad you mentioned the step-up in adjusted basis for capital assets. That issue is critically important and often overlooked. One priority of estate planning is to avoid paying capital gains on highly appreciated investments. The basis step-up gets you there w/r/t testamentary conveyances; but not for inter-vivos conveyances where basis carries over from donor to donee. (Hence the adage: "Death benefits those who wait.") If repealing the estate tax means we lose the step-up in basis at death, the consequences could be really harsh. I'm not sure people in Congress has thought this through and connected the dots. I recall there was speculation a few years ago that repealing the estate tax coupled with basis carryover (from decedent to heir) would be a net revenue raiser. (!!!) Similarly, whenever we see a revenue estimate for repealing the estate tax and it seems relatively modest, remember that it likely assumes carry-over basis.

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