The Estate Tax: A Constructive Discussion

I first want to thank Jim Maule for carrying the laboring oar in posting our correspondence. I think he fairly summarized both sides of the dialogue.

Rather than continue in the same dialogue format, I will simply outline points that I think, in their totality, strongly argue against a tax upon death of all untaxed capital gains (which, for purposes of brevity, I will refer to as the "CGUD Tax.")

The first of these is a sort of Burkean principle. That is, it is truly revolutionary to throw out a tax regime with a system of rules and decisional interpretations that has been built up over many years in favor of a wholly new design. For better or worse, I would err on the side of conservatism here (mark this date--it may be many years before you see this again). I believe that the current system, while in need of some tweaking perhaps, offers a fairly good design for taxing the transmission of wealth since the basic rules of the road are reasonably well established. The type of tweaks that I would suggest are, perhaps, indicative of my normative choices:

• One aspect of the current tax regime that contributed to the force of the political drive to abolish the estate tax in its entirety was the failure to automatically adjust the unified credit to take account of inflation. Thus, the initial credit amount, which was quite generous when it was first enacted, began to be seen as being too miserly when even those who considered themselves middle class began to cross the $600,000 threshhold. Though the lifetime credit has been raised, now to $1.5 million and soon, in increments, to $3.5 million, the earlier low credit amount has scarred the psyche of middle class taxpayers. I would like to see the credit set at some specific amount, say $2.5 million, that would automatically adjust based upon some sort of inflation index. (For reasons I won't go into here, I am not certain that the index should be the CPI.)


• I think that many of the abuses in the present system can be easily abolished, if by "easily abolished" one means that the technical means of abolition are simple. I have in mind here insurance trusts in particular. I suspect that if one means "easily abolished" in the political sense, insurance trusts would certainly not fall into this category, since the insurance industry is certain to lead an energetic charge in defense of its cash cow. However, other methods that are used to game the system, such as family limited partnerships designed to obtain lower estate tax valuations, could also either be repealed or be subjected to clear and unambiguous rules.


• Finally, the manner in which qualified plans are taxed has to be changed, since they are frequently subject to both income tax and estate tax at roughly the same time. I know that in subjecting them to tax in this way we are not really taxing them twice (after all, both the contributions and the subsequent earnings and asset value appreciation have not yet been subject to income tax), but that is not the perception of the public. I would subject to income tax an amount equal to the previously untaxed contributions and subject to the estate tax both that amount (net of income taxes) and all appreciation, allowing a step-up in basis of the assets.
  

Let me now address what I perceive to be some negative aspects of the CGUD Tax.

At the outset, let me note that I firmly believe that Jim is overly optimistic about making a CGUD Tax comparable in progressivity to the estate tax. As I noted in April, in a research paper published in 2000, The Distributional Burden of Taxing Estates and Unrealized Capital Gains at the Time of Death, James M. Poterba and Scott Weisbenner (using figures from 1998) concluded that:

[A]mong those with small estates ($1 million or less), taxing capital gains at death would collect more revenue than the current estate tax from roughly half of the decedents. For those with larger estates, replacing the estate tax with a tax on unrealized gains at death would result in a substantial reduction in total tax payments.

In order to engraft onto the CGUD Tax concept a degree of progressivity that we find in the current estate tax, Jim would really have to enact a wholly-new set of tax rules and tax rates. (E.g., The first $X million dollars in gains would be exempt and there would have to be a progressively increasing rate of tax imposed which, at some point, perhaps its upper end, would be significantly greater than current capital gains rates.) I suspect that, just as is the case with the income tax now, there would be numerous rules, exceptions, and exemptions built into the law by various interest groups.

This, together with Jim's proposed merger of the CGUD Tax with the gift tax, would leave us with a system that would be both extraordinarily complex and subject to a whole new set of rules. Because the new rules would not carry with them the years of judicial and administrative interpretation that go with the current estate tax, years of controversy and litigation would likely result. If this were the case, both Jim and I could probably extend our careers for the remainder of our natural lives (and perhaps longer if either of us wrote the definitive treatise on the CGUD tax), however, I somehow doubt whether this would endear either us or the CGUD Tax to the taxpaying public.

Furthermore, the current estate tax carries with it a strong incentive to make charitable contributions. Again, while it is evidence of a maverick streak of conservatism on my part, I think that encouraging the growth of charities is a good thing because it establishes a decentralization of power and influence. While some reforms may be necessary in this area (do we really want to continue a system where the inventor of Vicks VapoRub continues to exert political influence long after his death), it is reforms that are necessary, not a radical restructuring of the system.

Also, it just may be that the tax rate is too low at the upper end of the wealth scale. The Mars family, for instance, is reputed to be worth about $30 Billion. Can it reasonably be argued that if we reduce their family wealth to a mere $10 Billion we are inflicting upon them a grievous wound?

In concluding, let me suggest that, despite our differences, Jim and I share a good deal of common ground. Both of us, I think, believe that upon death there should be a progressive tax imposed, although we likely differ on the degree of progressivity that we would favor. Additionally, we both welcome true tax simplification, although we might differ on the paths to that goal.

Finally, although I don't want to commit Jim with respect to the politics of the current estate tax debate, I think that both of these concepts set us apart from the true radicals who want to abolish the estate tax.

Back to you, Jim.