ataxingmatter

Cost of Estate Tax Repeal

One of the patterns that we see in discussions of tax bills is that people generally find the statistics that they want to support the type of reform they have decided they want.  Yet if you look closely at the assumptions underlying those statistics, it becomes possible to separate the wolf in sheep's clothing out from the flock.

It's not any different in the current debate about the millionaire's estate tax.  In 2003, the American Family Business Institute, formed to protect the heirs of super-wealthy multimillionaires from having to part with some of their unearned wealth through the estate tax, hired Wilbur Steger and Frederick Rueter of CONSAD Research Corp. to figure out how much it would cost to repeal the millionaire's tax and replace it with a limited carryover regime (i.e., essentially the system that would exist for the one year of estate tax repeal under current law in 2010).

The CONSAD study, not unsurprisingly, concluded that there would be more money after repeal, by $1.74 billion for the period from 2004-2015.  But that study is based on a slew of flawed assumptions that overestimate the amount of money brought in by heirs' sales of estate assets and underestimate the amount of money lost through estate tax repeal.  John Irons, the director of tax and budget policy at the Center for American Progress, provides a concise examination of those "fundamental flaws."  Commentary Understates Cost of Estate Tax Repeal, 108 Tax Notes 241 (July 11, 2005). 

Irons notes that the pro-repeal camp assumes that the limited carryover basis approach can be implemented, in spite of the ultimate rejection of that approach when tried in the 1970s as simply unworkable.  The pro-repeal camp also assumes that repeal would lead to a surge of tax revenues from realization of capital gains. 

Those estimates just don't make sense.  First, they assume there are 25% more unrealized capital gains than the best estimates for large estates currently show.  Irons notes that reliable estimates suggest that about 56% of the value of estates worth more than $10 million consists of untaxed capital gains.  The CONRAD study, however, assumes that 70% of such estates is unrealized appreciation.  What is the source for this significant upward estimate?  It is anecdotal and unsubstantiated. 

Second, the CONRAD study assumes that all heirs will sell their entire portfolios within 3 to 5 years.  This is particularly unreasonable, since one of the reasons that the pro-repeal camp gives for repeal, as noted by Irons, is that paying the estate tax may force heirs to sell off long-held assets that they would rather hold onto for long term.  In fact, heirs are likely to hold onto assets considerably longer after repeal, since there would no longer be a uniform step-up in basis allowing them to sell tax free!

Third, the CONRAD study underestimated revenue loss from repeal of the estate tax.  It suggested $201 billion would be raised by estate taxes between 2005 and 2014.  Irons notes that number should be 310 billion, based on CBOs figures.  Furthermore, the loss of revenues also should include reductions in income tax estimated by both Treasury and CBO.

For all ordinary Americans who earn average wages and have few assets other than their homes and a few personal items, one fact from a 2001 study by Poterba and Weisbenner mentioned by Irons is especially worth remembering.  Based on 1998 estate tax data, eliminating the millionaire's estate tax and providing for a capital gains tax at death (with only a $250,000 deduction, under the Poterba study assumptions) would provide an average tax savings of $672,700 for those multimillionaires who are the only ones subject to the tax.

For another analysis of the reasons why repeal of the millionaire's tax doesn't make sense, see this report issued by the Center for American Progress after the House passed its repeal bill this year.

World Bank on Estate Taxes

On this blog and in my scholarly articles, I have argued that a country's tax provisions should work to enhance democratic egalitarianism.  Equity, not efficiency, is the primary yardstick by which we must measure our tax code.  By helping ensure that resource allocation decreases gaps between the rich and the poor, tax policies can undergird democratic institutions that permit the polity to work together for a better society, developing human and financial capital to serve the well-being of all the residents.

In particular, I have argued that the estate tax belongs in the panoply of tax mechanisms used to redistribute resources.  Death is an appropriate time for an accounting, since the entrepreneur who gathered those resources is no longer alive to make use of them.  Redistribution reallocates those resources across all the people, rather than allowing them to become concentrated in the hands of people who have done nothing to generate the economic growth.   If corporate ownership is passed intact at death, an ownership class arises that has no connection with the creative entrepreneurial spirit that founded the corporation even though that class controls vast amounts of corporate wealth.  The ability to identify with the problems of the underprivileged becomes attenuated, and the poor become invisible, as the underprivileged were in pre-Katrina New Orleans.

With an estate tax in place, a mechanism exists to ameliorate with each passing generation, to some extent, the inequities of wealth concentration.  The resources that would have become more consolidated in the hands of the privileged few can be made available to help people from all circumstances develop their potential and participate in the economic life.

The World Bank agrees with me, as noted in this description of its position on the use of inheritance taxes in developing countries.  In the World Development Report 2006, the World Bank notes that

“Because heirs have not earned the wealth, taxing gifts, estates and inheritances is consistent with the report’s notion that predetermined circumstances should not affect a person’s life chance.”

It goes on to state that taxing inheritances helps distribute ownership of the corporate engines of the economy across society.   An estate tax serves distributive justice by ensuring that the poorest among us have more of a chance for a decent life.  It also serves economic efficiency by preventing the ossification that can come from passing control of corporations down through family dynasties. A policy that is right because it is fair is also likely to promote more efficient use of resources--estate taxation advances both equity and efficiency.

"[Such] a design that restricts transfer of control rights on corporations can be good for both equity and efficiency.”

For further stories on the World Bank Report, see here and here.  To download the text of the report itself, see here.

Another argument frequently made in favor of a substantial estate tax for multi-millionaires is that the stable legal, economic, and social institutional environment provided by the state is a significant factor in any person's ability to amass a fortune.  Consequently, it is appropriate that some accounting be made at death, to pay over to the state some portion of the fortune in recognition of the role of the state in making the fortune possible.  Those funds then support human capital expansion for others, leading to a constantly rejuvenated economic entrepreneurship that promises a better life for all.

That argument was, interestingly, supported in the amicus brief in a case involving major research universities and the Solomon Amendment.  As you may recall, the Solomon Amendment has been used by the military to claim that it has the right to ready access to universities for recruitment purposes if those universities receive any federal research grants. 

There are various reasons why the Solomon Amendment should be found unconstitutional, especially if it is interpreted, as the military interprets it, to grant the military access in order to stifle the universities' message that the military's anti-gay policy is discriminatory and not worthy of American values.  If you are interested in reading those arguments, you may want to read the various briefs in Donald Rumsfeld vs Forum for Academic and Institutional Rights. 

But it was something else that I found particularly interesting in the amicus brief filed by Columbia, Cornell, Chicago, Harvard, New York University, Pennsylvania and Yale.  The brief articulates the essential role of research universities in the economic and social life of the country.  Here are two short paragraphs explaining the importance of federal taxpayer dollars in support of basic research at major research universities.

By any relevant measure, the unencumbered provision of federal funds for university research has been .exceptionally productive.. Nat.l Science and Technology Council, supra, at 331. The results of that partnership are ubiquitous and indispensable; they touch almost every factor of modern life. The computer on which this brief was written is a descendant of the Whirlwind, the world.s first high-speed, general purpose, electronic digital computer, which was developed at MIT with federal funds. MIT, The Federal Government and the Biotechnology Industry: A Successful Partnership (1995), available here .The Internet, now an integral part of society, began as a network of computer science departments funded by the National Science Foundation. National Science Foundation, The Nifty Fifty, available here. (last updated Jan. 27, 2005). The biotechnology revolution, which has spawned most of themedications on which we depend, emerged from pioneering academic research conducted with funds from the National Institutes of Health. Arthur Kornberg, Support for Basic Biomedical Research: How Scientific Breakthroughs Occur, in The Future of Biomedical Research 38 (Claude E. Barfield & Bruce L.R. Smith eds., Washington, DC: American Enterprise Institute & The Brookings Institution 1997). Federally funded academic research on fiber optics paved the foundation for the modern telecommunications era. National Science Foundation, supra. Indeed, the social value of basic research conducted at America.s universities is difficult to overstate: secure credit-card transactions, lasers, doppler weather radar, sign language, even the yellow highway barrels that minimize injuries from car collisions. all of these mainstays of daily life, among many others, likely would not exist without it. See id. 

These innovations have contributed enormously to the national economy. Studies estimate that roughly one-third of the total value of the NASDAQ market stems from federally funded university-based research. Margo Carmichael Lester, Federal Funding Spurs Private Innovation, LARTA Vox (Nov. 3, 2003), available here. In the high-technology sector, where federal funding of academic research is most robust, America is the world leader, accounting for about one-third of global production. National Science Board, Science and Engineering Indicators -2004, at 6-8. And because .U.S. high technology industries have been more successful exporting their products than other U.S. industries, [they] play a key role in returning the United States to a more balanced trade position. in a time of growing deficits. Id. at 6-11.

Without the fundamental research mission of our major research universities, we would likely never have discovered various technologies that we use daily to make our lives better, from medicines to the internet.  And much of that research would never have been conducted without the support of federal tax dollars.  The tax dollars paid by you and me (and, hopefully, by rich people too) turn around and support cutting edge research that in turn ultimately results in new businesses, new medical treatments, and even new forms of art.  The cycle of tax dollars from entrepreneur to entrepreneur is the wonderful saga of a democratic society at work.  That work is made more possible by mechanisms such as the estate tax.   

Katrina Aftermath

Congress today is poised to pass an emergency tax bill with numerous provisions meant to ease the burden on Katrina's victims, according to this announcement from the House and Senate tax writing committees.  Information (including summary, bill text, and revenue estimate) regarding HR 3768, Katrina Emergency Tax Relief Act (KETRA) is available here.  The Joint Committee's explanation of the Senate version of the bill is here. 

For a concise overview of the provisions, see Professor James Maule's blog posting here.   The bill provides for withdrawals from retirement accounts without penalties, suspends the limitations on charitable contributions in connection with Katrina relief, waives the threshold requirements for Katrina casualty losses, extends the period for nonrecognition in connection with involuntary conversions, and provides employee relief, among other provisions.

The overall cost of Katrina relief, whether in the form of these tax provisions or the many other emergency response costs (including building temporary and permanent housing) will be enormous.  After his initial failure to show concern for Katrina victims, Mr. Bush has made a point of being seen in the storm zone and of making strong promises to help victims restore some normalcy to their lives.  While the display of compassion is commendable, Bush's promises of aid, estimated to run as high as $200 billion, are notably devoid of any explanation of the means for making good on the promise. 

As earlier posts on the deficit and budget situation in the context of the AMT have made clear, this country already runs record deficits funded by disproportionate borrrowing, especially from foreign countries like China, Japan and the Caribbean tax havens.  Pre-Katrina deficits were projected at $330 billion for this year.  Katrina costs (and, of course, Iraq war costs) will propel that figure much higher.  Borrowing already approaches $8 trillion and is expected to top $11 trillion in a few years.  If these additional expenses are paid for by additional deficits and borrowing, a stiff  burden will be borne by workers in the future.

What's the alternative?  The one solution that Bush suggested he would not apply--raising taxes on the wealthy to fund the government functions that we all know are necessary.  The 2001-2004 tax rate cuts for the wealthiest Americans should be withdrawn, the repeal of the millionaire's estate tax should be undone, and the rates on the highest income Americans--those that make more than $10 million annually--should be raised somewhat beyond the pre-2001 highest rate, to 45%. 

Will this Congress take those necessary steps?  It is not at all clear, given its past record of debt-financed tax cuts.   Will the Congress instead cut spending on programs vital to the well-being of ordinary Americans who don't belong to the privileged wealthy upper crust?  That is in fact what many, such as Bush ally Grover Norquist and others, have recommended.  It would be a shame if this disaster, which brought to the forefront the plight of the disadvantaged, were to serve as a springboard for both more tax cuts for the wealthy and more benefit cuts and debt burden for the poor and middle class.  Hopefully, Congress will recognize the folly of continuing its tax-cut-and-spend ways of the last four years.

Katrina's Tax Lesson

          If you can at all afford to do so, please contribute to help the displaced victims of Katrina!  You can also contribute here or here to help fund the rescue and care of the thousands of displaced pets in New Orleans and elsewhere.   

          The last ten days have been difficult ones, as the Katrina disaster has unfolded.  The problems and lack of preparation were scandalous.  See this discussion and this one.  As the weak, the poor, the sick, and the elderly suffered in desperation waiting for governmental aid that should have been at the ready, we--and the world with us--recognized the price we are paying for the tax policy of the last five years. Tax cuts have gone predominantly to the benefit of the wealthy, and health and environmental safety nets have fallen by the wayside.  Tax expenditures and special breaks have flowed to the oil companies who are making a killing out of high oil prices in the midst of an inventory surplus.  Even as Katrina hit, Congress was planning how to cut taxes for the wealthy even more by making the dividend rate cut and millionaire's estate tax repeal permanent.  To pay for those tax cuts, Congress was also planning cuts in medicare, food stamps and other programs for the neediest of the needy.   

          Katrina has made it all too clear that such reckless fiscal policies create only Third World conditions.  The wealthy in New Orleans were able to flee safely to hotels or new apartments.  The mostly poor, mostly black and frequently sick or elderly who were left had no car, no bank account, and no way to find shelter.  We all saw their desperation and felt their need.  The poor, at least for a few days, are no longer invisible in America. 

          Instead of passing more tax cuts for the wealthy, likely to be invested in offshore banks and overseas businesses (that steal even more jobs from ordinary Americans) or used to pay high-priced accounting firms for a tax shelter scheme to avoid taxes altogether, Congress should roll back the tax cuts and embark on a renewed commitment to use our combined wealth to re-create the land of opportunity that we claim to be.   We have to think openly and deeply about tax policies, and realize that the many government functions that are supposed to protect us and make possible a sustainable market economy and civilized society cannot work without taxes to support them.  This discussion goes on now among academics and increasingly in the blogosphere as tax experts argue the merits of tax policies in ways little seen on the floor of Congress these days.  See, for example, this post by fellow tax professor James Maule. 

          It is time for the discussion to go on in Congress and throughout the country, time for our tax policies and our aid policies to reflect the long term needs of a country with increasing income disparities.  Let us enact a new program of college grants for the needy, to ensure that every American can receive an education that permits them to move ahead.  Let's fund the program by taxing capital gains and dividends the same as ordinary income.  Let's ensure that every American has the right to adequate health care.  Let's fund that program by taking back the billions in corporate tax breaks passed in the 2004 Jobs Act and 2005 energy bill, among others, from allowing corporations to expense capital expenditures to permitting them to cross-credit most foreign taxes.  Let's invest now in energy conservation, not environmental degradation, as discussed in this article by environmentalist McKibben.  For once, let's start to think about the long term well-being of this country and all its citizens, and let's make the hard decisions and shared sacrifices that sustainable well-being requires, including enacting higher progressive rates on those making $1 million or $10 million or more.