The Senate Finance Committee held hearings today (Nov. 14, 2007) on the federal estate tax. The title of the hearings suggests the direction the committee leaders are heading: "The Federal Estate Tax: Uncertainty in Planning Under the Current Law."
One might think that the Democratic Chair, Max Baucus, would consider it important to have the revenues from the estate tax (about $24 billion annually) rather than lose those revenues at a time when there are demands for finding revenue sources to ensure that the Alternative Minimum Tax system doesn't grab taxpayers too far down the income distribution. $24 billion is not a trivial amount, even though the only estates that ultimately have to pay tax are the truly big ones. In a country with increasing inequality, we need whatever measures we have and a few more besides to help prevent democracy sliding into plutocracy, as Warren Buffet and others have said. The estate tax, which doesn't come into play until the person who accumulated the estate can no longer benefit from it, is a reasonable item in the defense against plutocracy.
Regretably, Baucus appears to have bought the bill of goods being pushed by the coalition of extraordinary wealthy families like the Wal-Mart heirs and others. His statement today says point blankly that he "support[s] repeal." then it goes on to say that there is a need to provide certainty for "the farmers and ranchers of Montana." Baucus does acknowledge that the "tale" of the tax is worse than its actual bite and that very few estates are actually subject to tax. Only three in one hundred small businesses end up with ANY estate tax liability--that is not a big threat of liquidation of the business to pay the estate tax.
Not unexpectedly, Grassley (representing the minority party) goes Baucus several better in his statement. He talks about the estate tax swooping in after a death to "take a cut of what that person had worked their whole life for, and has already paid taxes on at least once." Of course, that is not necessarily true and even if true, that person's lifetime taxes as a proportion of income may be very low--below what we might consider to be a de minimis obligation in a democracy. That person may have inherited the estate to start with, received a step-up in basis on all the assets, and lived off the earnings of the estate. Taxes may have been very low (perhaps all at the capital gains rate) or zero (if the estate consisted almost entirely of items that produce excluded income). With inherited wealth, most of the wealth may have in fact escaped tax across several generations. Meanwhile, the ordinary guy who has to work two jobs to make a decent living for his family is paying full tax at ordinary income rates on everything above the exemption amount. An anecdotal story that goes the other way doesn't provide much reason for taking action against the tax.
Grassley's rhetoric gets more out of bounds as the statement goes on. He of course uses the loaded term developed by the lobbyists for repeal of the estate tax--the "death tax" and says that death is a poor time for taxation. In fact, death is an ideal time for taxation since the decedent has no more use of funds and it is clearly a point of transfer that we would ordinarily think of as a realization event. The government, as I've often said, is a reason the estate was able to grow as much as it did, so it is reasonable that the government receive a share at the time of transfer. Those who inherit haven't had control before, so whatever they get is a windfall, though they tend to think of it as a right to continue what their parents or grandparents may have started.
Grassley objects that those who inherit the large estates don't get to choose the timing of their inheritance and thus don't get to time the market on whatever assets are sold. He claims the "free market" determines when other sellers sell. But Grassley is wrong here. Death is just one of the various fickle things life throws in the way of the perfect market transaction we'd all do if we had perfect foresight. The fickle finger of fate affects any sale of assets--even if you are carefully calibrating for the greatest gains, you can wake up the morning you chose to sell and find the deal sunk by a disrupted market. Take any house for sale in a depressed area of the country--if it had been put on the market in the middle of 2006 versus the middle of 2007, it might well have been sold more easily for a much higher price. Stock prices can change in the blink of an eye. And estates don't have to sell in one day--nine months is a fairly long time for liquidating whatever assets need to be liquidated (and as we know, in many cases an estate need not be liquidated, since the effective tax rate is very low--around 14% for the largest estates, and there are installment provisions that apply in many cases.
But it's Grassley's next statement that takes the cake for misrepresenting the way the estate tax works. Here's what he says: "As most people are not privy to exactly when they will hand over half of everything they own to the government, the death tax is fundamentally not fair." Of course, Grassley knows that estates don't pay over "half of everything they own" to the government, so this is just misleading rhetoric meant to keep ordinary taxpayers in the dark about the way the estate tax works, and make them think that they are all going to have to pay a huge tax and lose everything. Most estates don't owe any estate tax at all, and for the very few that do, there are both a number of tax planning strategies (generation skipping trusts, etc.) and a number of significant exemptions that apply. The tax only applies to the amount over the exemption and not protected by those various devices.
Grassley does what all the anti-estate tax people do--they reduce it to a story of a family business that everybody is worried about having to pay an estate tax. The idea is one sympathetic family will allow Congress to repeal the entire estate tax. Funny, many more sympathetic families don't lead Congress to pass better minimum wage laws, health care laws (look at S-CHIP) or other provisions. So Grassley ends his statement with the need to look out for "small business owners and family farmers"--the mythical favored party that we need to protect from the beast of the estate tax.
Grassley gives us Mr. Sukup, Chairman of the Board of Sukup Manufacturing in Iowa, to tell his tale--see statement here-- of why we should protect his family from paying any estate tax. Sukup started a business 44 years ago, and his sons are now part of the worldwide business with 350 employees that sells products in the US and 50 countries. The company hires great employees, provides good benefits, and is in a great community (I suppose he means the city of his main manufacturing plant, since he said he has distribution centers in several states). The company makes a lot of money, but gives a good bit of its profits to charity. Sukup says the community would lose if his business was shuttered, and claims that his sons would probably have to liquidate if he and his wife died because of the estate tax obligation of around $15-20 million. Planning might avoid that, he says, but would prevent even more expansion of the business. Uncertainty of tax means you'd have to plan for the worst case scenario. Tax paid by one generation wouldn't prevent the next generation from having to pay tax as well. Sukup concludes by saying he built the company and the tax will destroy it and that is unfair.
First, even at the higher pre-2001 rates, estate tax opponents found it hard to find any real businesses that had actually been liquidated to pay the federal estate tax. That leaves us somewhat dubious about Sukup's claim that it would be necessary to liquidate the business merely to pay the estate tax due. After all, most successful businesses make good collateral for loans. The sons could take out loans to pay any actual estate tax obligation, and pay those loans off over time from the cash flow of the business.
Second, Sukup's statement that planning is not reasonable appears in itself unreasonable. If a business is making millions annually and doing so well, it would be reasonable to plan for eventual liabilities. Businesses do that every day, and there is no reason that we should treat the estate tax as evil because it requires similar planning for businesses to the types of planning they do for other contingent, uncertain, but expected liabilities.
Third, economic efficiency arguments tend to suggest that businesses should expand and any impact of tax on business expansion is per se bad. But expansion possibilities are not unlimited, and megabusinesses are not necessarily good for a community. It might in fact be better sometimes for businessses to be broken up into more than one smaller businesses. Employees that work for the business in the many different states where the business currently has distribution centers might find themselves more content with bosses that are closer to home. But the ability of families to maintain control across generations tends to have a lock-in effect, leading businesses ultimately to stagnate. Sukup's story assumes that his family should always be able to run the business he started.
Fourth, Sukup suggests that he has played a role as benevolent donor to his home state and area charities and suggests that would cease with another owner upon liquidation. Yet another owner could be local and interested in the community as well. Is appreciation of some businesses' current acts of benevolent patronage a reason for eliminating the estate tax?
Fifth, Sukup talks about being an entrepreneur who has built a business that his sons and grandchildren want to carry on. He says the tax discourages entrepreneurs. Yet he is proof that it does not--he developed a new business and made it succeed, in spite of knowing that there was an estate tax. In fact, for most of the time that he was being a successful entrepreneur developing a new business, the tax had a much bigger bite than it does right now.
Here's the problem. We all feel empathy for people who have become used to a certain way of life, and we don't like the idea of the government being the reason that way of life should change. But that empathy shouldn't lead us to scuttle a tax that provides one of the few restraints on wealth accumulation in our current economic setup. The ridiculous uncertainty built into the Code with the 2001-2003 tax bills should not now provide a justification for again enacting a fiscally irresponsible set of revenue reductions into the Code that provide great reductions in tax liabilities to the wealthier amongst us while continuing to demand a fairly high tax burden from ordinary taxpayers. Let's not repeal the estate tax, but find a reasonable exemption and tax rate, set it there, and then stop this endless attempt to repeal it. At this point, we probably should just retain the 2009 provisions ($3.5 million exemption and 45% rate). Any further reductions or repeal would be both fiscally irresponsible and democratically worrisome.
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