I argued in a recent post that certain claims by conservatives about taxes have been definitively refuted yet continue to be repeated. In particular, we often hear the claim that the estate tax forces families to sell or break up their businesses and farms upon the death of the parent who founded the company or farm. This claim has never, to my knowledge, been demonstrated with even a single example; yet the claim is heard over and over again. The Wall Street Journal editorial page rails about it ("[N]o policy that penalizes the thrifty and busts up family businesses belongs in our tax code, whatever its effect on Paris Hilton."), and it sometimes seems that every Republican candidate must repeat the phrase endlessly in his (or occasionally her) sleep.
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Typically, these rote repetitions of the claim are not offered with proof but are simply chanted as articles of faith. Last week, though, the Joint Economic Committee of the United States Congress, under the name of the Chair, Rep. Jim Saxton (R., N.J.), released a study called “Costs and Consequences of the Federal Estate Tax,” a 41-page report (the Report) that purports to demonstrate the disadvantages of the estate tax, including its deleterious effects on family businesses. The cover page, with the title of the Report above an American Eagle seal and Rep. Saxton’s name, includes an Executive Summary with the following four bullet points:
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• The estate tax impedes economic growth through high compliance costs and economic inefficiencies, and has reduced the stock of capital in the economy by approximately $847 billion.
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• The estate tax hinders entry into self-employment and breaks up family-run businesses, many of which lack the liquid resources needed to meet their estate tax obligations. The tax is also an impediment to upward income and wealth mobility.
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• Much research indicates that the estate tax is an ineffective tool for fighting wealth and income inequality. In fact, some estimates indicate that the tax exacerbates inequality.
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• The benefits of the charitable deduction are often overstated, with recent research indicating the tax has only a modest, if any, impact on gifts to charity.
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Obviously, the first bullet point is highly suspect, and I hope to explore that claim in a future post. For now, though, I will focus on the second claim, because it offers the promise that, at long last, there is proof that the estate tax “breaks up family-run businesses.” Not that the estate tax could in theory break up family businesses, or that there is some equivocal evidence as to whether it breaks up family businesses, or that one might reasonably suspect that it breaks up family businesses. No, the Joint Economic Committee summarizes its findings in the Report as demonstrating that the estate tax does, as a matter of fact, break up family-run businesses.
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If this assertion were supported in the Report itself, that would be quite a coup. Opponents of the estate tax, after all, would love to have proof of this claim. That the claims in the Report did not make the evening news, therefore, strongly suggests that there is nothing new here. Indeed, there is not. To appreciate fully the emptiness of the Report’s claims requires a bit of tedium, but the results of the inquiry are very revealing.
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Section IV.B. of the Report, running from page 19 through page 22, is entitled “Family Businesses and Entrepreneurial Activity.” The lead paragraph again makes an affirmative claim that the estate tax breaks up family-run businesses. The following paragraph then helpfully runs through a few of the existing provisions in the tax code that allow families to pay any estate tax due without selling the farm or business, in particular an available 14-year installment plan as well as special favorable valuation rules that were included in the Bush 2003 tax cut package.
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The Report quickly asserts, though, that these provisions “are often inadequate to prevent the estate tax from breaking up many family businesses” (p. 19). Note that we have now gone from a generic assertion that the estate tax breaks up family businesses to the stronger assertion that even these pro-taxpayer provisions are “often” not enough to prevent the estate tax from dooming “many” family businesses.
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The argument offered for this conclusion is curious. The JEC asserts (based on an article from Tax Notes in 2005) that the pro-taxpayer protections are too complicated and therefore that few estates use them. They then point out that, of over 100,000 estate tax returns filed in 1999, of which 11,000 included a closely-held business interest, only a small percentage of taxpayers took advantage of the various provisions available. (The Report does not point out that less than half of the estates that filed tax returns owed any tax at all, nor did it mention that the median taxable estate’s rate was less than 11%. See this CBO report, p. 9, tbl. 3). The Report points out, though, that “a relatively meager 524 returns elected to use the extended payment option” (p. 20).
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What this seems to argue is that, because people are not using these special provisions, the provisions must be inadequate. But if the provisions were really inadequate, a large number of people would be using them for all they were worth and begging for more. If a tiny minority of estates are using the 14-year plan to spread out payments, the most reasonable conclusion is that the vast majority do not need to spread out their payments.
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The claim in the Report, though, is that the provisions are too difficult to use. If that is the case, then it argues for simplification, not repeal. In any case, the argument at best explains how estate taxes could break up family businesses even in the presence of certain protections, not that estate taxes actually do break up family businesses. The Report assumes its own conclusion.
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The Report then moves on to trying to impress the reader with large numbers. Aggregating estates over the ten year period from 1995-2004, the Report concludes that “tens of thousands of small and family businesses, worth $104 billion, were subject to the estate tax over the last ten years. These data clearly indicate that the estate tax has broad and significant costs for thousands of family businesses” (pp. 20-21).
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Why aggregate in this way? If I aggregated wages paid over a ten year period, the number would be much larger than wages paid in a single year. Given that people pay taxes on their wages, such data would also “clearly indicate that [payroll and income taxes have] broad and significant costs for thousands of [workers],” in the JEC’s words. Why does that matter? The Report’s own numbers indicate that the average year from 1995-2004 saw $10.4 billion in small and family businesses subject to the estate tax. The only argument that the JEC could be making here is that not all small businesses are entirely exempt from the estate tax. I do not know of anyone who argues that they are, but even if they did, the important question is whether any of the family-run businesses that the JEC is describing have been put out of business by the estate tax. No evidence is provided to show that this has happened even once.
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At this point, the Report veers onto a completely different course. Having told us how many (or how few) estates are subject to the estate tax, and how much they were worth over a ten year period, it now offers survey data that “suggest that the estate tax continues to be a primary reason why small businesses fail to survive beyond one generation” (p. 21). The Report then rattles off the following survey results:
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· “Close to two-thirds (64 percent) of respondents in one survey of family businesses reported that the estate tax makes survival of the business more difficult.
· “In other surveys, 87 percent of black-owned firms and 93 percent of manufacturing firms responded that the estate tax was an impediment to survival.
· “A survey of family business owners by Prince & Associates found that 98 percent of heirs cited ‘needed to raise funds to pay estate taxes’ when asked why family businesses fail.”
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We are thus presented with three surveys. The first two show large numbers of respondents saying that the estate tax is an impediment to survival, but they do not actually say that estate tax liabilities caused any of those businesses to fail. I suspect that most people would be likely to describe any of their expenses as “an impediment to survival.” Rent or mortgage payments are an impediment to survival. Electric bills are an impediment to survival. Tuition is an impediment to survival. Income taxes are an impediment to survival. Every expense is an impediment to survival, at least in a sense in which one could honestly say on a survey that an expense “makes survival ... more difficult.”
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The first two surveys, therefore, contribute nothing to the discussion. We know that people do not like to pay taxes, and they will understandably respond to surveys in a way that makes it clear that they would like to reduce their tax liabilities. The third survey result, though, at least appears to be on point. If it were true that 98 percent of failed family businesses had failed because of a cash crunch due to the estate tax, that would be news. Of course, we would need to worry about possible bias of the respondents to such a survey or whether the survey instrument was written in a way that rigged the results. That is why congressional reports should follow rigorous citation requirements.
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The Report’s citation (p. 21, footnote 94) for that third survey is, in fact, quite informative in its way. The survey apparently was included in a book called Marketing to Family Business Owners (Cincinnati, OH: National Underwriter, 1995). The lead author is someone named Russ Alan Prince, who is described on one website as being “internationally recognized as one of the world's foremost experts on the high-net-worth investor.” (The co-author of the report seems to be Prince’s regular co-author.) We thus have a survey from 1995 from a source who does not even claim to be an expert in survey research but who does market his work to people who are likely to oppose the estate tax. (The following year, the authors of the cited book published Marketing to the Affluent: A Toolkit For Life Insurance Professionals.)
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The problem, of course, is not that two people wrote a book explaining how to market financial services to family business owners. The problem is that the Joint Economic Committee of Congress cites that source eleven years later for the claim that family businesses fail because of the estate tax.
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Indeed, a touch of embarrassment crept into the Report. Here is the muted claim that follows the recitation of the survey results noted above: “Even if only a small percentage of the 550,000 small businesses that fail annually are attributable to the estate taxes, the cumulative number affected over time could be substantial. In the context of the survey and tax data described here, it is easy [to] see how the estate tax has contributed to the failure of thousands of small and family-run businesses” (p. 21).
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We have now gone from the assertion that the estate tax breaks up “many family businesses” to the claim that the “cumulative number affected over time could be substantial.” The survey data, we are told, make it “easy to see” how the estate tax has “contributed to the failure” of thousands of family businesses.
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Finally, the Report cites research by three well-respected economists in an attempt to support its case. Douglas Holtz-Eakin (the now-departed head of the CBO) and two co-authors published a paper in 2001 investigating whether owners of small businesses buy insurance policies to allow their heirs to hold onto the business while paying any estate tax due. (The paper is “Estate Taxes, Life Insurance, and Small Business,” Douglas Holtz-Eakin, John W. R. Phillips, and Harvey S. Rosen, Review of Economics & Statistics, February 1, 2001, 83(1), pp. 52-63. The Report cites a 1999 working paper version of that paper.)
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The Report (p. 22) cites the following sentence from the Holtz-Eakin et al. paper: “Our results suggest that owners of businesses buy more [life] insurance than other individuals, but even together with the liquid assets in their portfolios, there is insufficient money to cover estate taxes.” The Report then asserts that “estate taxes cause such disruption to family businesses” because of firms’ liquidity constraints.
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Holtz-Eakin and his co-authors, though, never said that estate taxes cause disruptions in family businesses. Instead, they were trying to figure out why, if keeping the family business together was such a priority, more owners of small businesses did not purchase sufficient insurance to cover expected estate tax bills. Here is the text that immediately follows the sentence quoted in the Report (and which concludes the paper):
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“This finding has several interpretations. One is that there are other means to cover estate taxes that do not show up in our data. The heirs, for example, might have substantial liquid assets. A second possibility is that, contrary to the popular view that keeping a business in the family is very important to business owners, they make no special efforts in this respect. In any case, we have found no evidence that business owners fully exploit life insurance to meet estate tax liabilities.” Holtz-Eakin et al. p. 63
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In other words, the closest thing that the JEC has to a credible source regarding the “burdens” of the estate tax cannot rule out the possibility that heirs are able to pay estate taxes if they want to hold onto the family business; and the economists who wrote the study even suggest that business owners might not care enough to do all they can to keep the business in the family. The latter possibility means that, even if we do someday find evidence of businesses that were “busted up” by the estate tax, we cannot be sure that that was even a bad result from the standpoint of the decedent.
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Of course, none of this matters politically. The executive summary of the Report is what most people will see, and there we learn again that the estate tax breaks up small businesses. Too bad that claim is still not backed up by evidence.
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Neil H. Buchanan, guest blogger
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EVIDENCE?? WE DON'T NEED NO STINKING EVIDENCE! Thanks to Driftglass for sending me over to your blog...good reading!
Posted by: Mr. Natural | May 15, 2006 at 01:13 PM