Estate Tax Repeal:
A Windfall For The Wealthiest Americans
by Iris J. Lav and James Sly
Summary
On May 25 the House Ways and Means Committee passed legislation introduced by Chairman Bill Archer that would repeal the federal estate, gift, and generation-skipping transfer tax by 2010.
Repealing the estate tax would provide a massive windfall for some of the country's wealthiest families.
- In 1997, the estates of fewer than 43,000 people — fewer than 1.9 percent of the 2.3 million people who died that year — had to pay any estate tax. The Joint Committee on Taxation projects that the percentage of people who die whose estates will be subject to estate tax will remain at about two percent for the foreseeable future. In other words, 98 of every 100 people who die face no estate tax whatsoever.
- To be subject to tax, the size of an estate must exceed $675,000 in 2000. The estate tax exemption is rising to $1 million by 2006. Note that an estate of any size may be bequeathed to a spouse free of estate tax.
- Each member of a married couple is entitled to the basic $675,000 exemption. Thus, a couple can effectively exempt $1.35 million from the estate tax in 2000, rising to $2 million by 2006.
- The vast bulk of estate taxes are paid on very large estates. In 1997, some 2,400 estates — the largest five percent of estates that were of sufficient size to be taxable — paid nearly half of all estate taxes. These were estates with assets exceeding $5 million. This means about half of the estate tax was paid by the estates of the wealthiest one of every 1,000 people who died.
- If the estate tax had been repealed, each of these 2,400 estates with assets exceeding $5 million would have received a tax-cut windfall in 1997 that averaged more than $3.4 million.
As these statistics make clear, the estates of a tiny fraction of the people who die each year — those with very large amounts of wealth — pay the bulk of all estate taxes. Moreover, a recent Treasury Department study shows that most of the estate taxes are paid on the estates of people who, in addition to having very substantial wealth, still had high incomes around the time they died. The study found that 91 percent of all estate taxes are paid by people whose annual incomes exceeded $190,000 around the time of their death.
Small Businesses and Family Farms
It often is claimed that repeal of the estate tax is necessary to save family businesses and farms — that is, to assure they do not have to be liquidated to pay estate taxes. In reality, only a small fraction of the estate tax is paid on small family businesses and farms. Current estate tax law already includes sizable special tax breaks for family businesses and farms.
Moreover, to the extent that problems may remain in the taxation of small family-owned businesses and farms under the estate tax, those problems could be specifically identified and addressed at a modest cost to Treasury. Wholesale repeal of the estate tax is not needed for this purpose.
- Farms and family-owned business assets account for less than four percent of all assets in taxable estates valued at less than $5 million. Only a small fraction of the estate tax is paid on the value of farms and small family businesses.
- Family-owned businesses and farms are eligible for special treatment under current law, including a higher exemption. The total exemption for most estates that include a family-owned business is $1.3 million in 2000, rather than $675,000. There also is a special way to value family-owned businesses and farms for purposes of the estate tax, which can reduce the value placed on them for estate tax purposes by as much as $770,000. Still another feature of current law allows deferral of estate tax payments for up to 14 years, with interest charged at rates substantially below market rates.
- If policymakers wish to do so, they can change the law to exempt from the estate tax a substantially larger amount of assets related to family-owned farms or businesses, without repealing or making other sweeping changes in the estate tax. For example, a targeted proposal put forth by some Members of Congress in 1999 would have provided very substantial estate tax relief to family-owned farms and small businesses at a cost of approximately $1 billion a year.
Effective Estate Tax Rates Much Lower than Marginal Rates
The estate tax is levied at graduated rates depending on the size of the estate; the highest tax rate is 55 percent. This sometimes leads people to conclude that when someone dies, half of their estate will go to the government.
It normally is not the case that half of an estate is taxed away, however, because effective tax rates for estates of all sizes are much lower than the marginal tax rate of 55 percent. On average for all taxable estates in 1997, estate taxes represented 17 percent of the gross value of the estate. In other words, a combination of permitted exemptions, deductions, and credits, together with estate planning strategies, reduced the effective tax rate to less than one-third of the 55 percent top marginal tax rate.
Repeal of the Estate Tax Carries A High Cost
Repealing the estate tax would be very costly. According to the Joint Committee on Taxation, the Archer proposal would cost $105 billion over the first 10 years, as it phased in slowly. Once the proposal was fully in effect — and the estate tax had been repealed — the proposal would cost about $50 billion a year. The cost of the proposal in the second 10 years — from 2011 to 2020 — would be nearly six times the cost for 2001- 2010.
- Under Chairman Archer's proposal, the estate tax would be reduced gradually over the next decade, leading to full repeal in calendar year 2010.(1) Under current law, CBO projects the estate tax will bring in $48 billion a year by 2010.
- In the 10 years between 2011 and 2020, the estate tax likely would bring in at least $620 billion under current law. The Archer proposal includes a provision, relating to the valuation of capital assets when a person dies, that would offset a small portion of the revenue loss from repeal of the estate tax. The offsetting revenue gain is likely to be in the range of $5 billion to $10 billion a year.
The net effect of the Archer proposal when fully phased in thus would be a revenue loss likely exceeding half a trillion dollars over 10 years.
The very high cost of repeal would be felt fully in the second decade of this century. That is the period when the baby boomers begin to retire in large numbers, substantially increasing the costs of programs such as Social Security, Medicare, and Medicaid. As a result of those increased costs, and the relatively slow growth in the labor force that is anticipated, the Congressional Budget Office has projected that total budget surpluses will begin to decline during this period and eventually turn into large and rapidly growing deficits even if there are no changes in current policies — that is, even if there are no additional tax cuts. Those deficits will ultimately generate pressure for reductions in Social Security, Medicare, and Medicaid benefits and limit the funds available to meet high priority needs such as improving educational opportunities, expanding health insurance coverage, and reducing child poverty. Repealing the estate tax would significantly increase those pressures.
Most Estate Taxes Are Paid by Large Estates
Most estate taxes are paid by large estates rather than by small family-owned farms and businesses. As noted above, the first $675,000 of an estate is exempt from taxation in 2000, with the exemption scheduled to rise to $1 million by 2006. In addition, an unlimited amount of property can be bequeathed to a spouse free of estate tax.
Moreover, each member of a married couple is entitled to the basic $675,000 exemption. A number of simple estate planning devices are available under the law, the net effect of which is to double the amount a couple can exempt from estate taxation. Thus, a couple can effectively exempt $1.35 million from estate tax in 2000, rising to $2 million by 2006.
As a result of these exemptions and other provisions, such as unlimited deductions for charitable giving, only about two percent of all deaths result in estate tax liability. Of the 2.3 million people who died in 1997, for example, fewer than 43,000 had to pay any estate tax.(2)
Of those estates that are taxable, it is the largest estates that pay most of the estate tax. An analysis by IRS of the 42,901 taxable estates filing in 1997 showed that the 5.4 percent of taxable estates with gross value exceeding $5 million paid 49 percent of total estate taxes. In other words, about half the estate tax was paid by the estates of just 2,400 people — about one out of every 1,000 people who died. The 15 percent of taxable estates with gross value exceeding $2.5 million paid nearly 70 percent of total estate taxes.(3)
The average estate tax payment for the 2,400 taxable estates with assets exceeding $5 million in 1997 was $3.47 million. Thus, if the estate tax had been fully repealed for 1997 filers, fewer than 2,400 of the wealthiest people who died would have received a tax-cut windfall averaging more than $3.4 million each. A few hundred of the very wealthiest people who left estates exceeding $20 million would have received a tax-cut windfall of more than $10 million each.
Estate Tax Payers Also are High-Income
A new analysis by the Treasury Department looks at the annual income of decedents who pay estate taxes. The Treasury analysis finds that virtually all estate taxes — 99 percent — are paid on the estates of people who were in the highest 20 percent of the income distribution at the time of their death. Some 91 percent of all estate taxes are paid decedents with annual incomes exceeding $190,000 around the time of their death.(4)
Tax Share of Estates Far Lower than Marginal Rates
It often is claimed that estate tax rates are too high and that the government should not be taking as much as half of a person's lifetime savings when he or she dies. The assertion that the government takes half of a person's estate stems from the fact that the estate tax is levied at graduated rates, with the highest marginal rate of 55 percent applying to estates with a value exceeding $3 million.(5)
Data on estate taxes actually paid, however, show that estate taxes represent one-sixth the value of the average estate, not one-half. As shown in Table 1, estate taxes paid equaled 17 percent of the gross value of taxable estates for which estate tax returns were filed in 1997. The smallest and the largest estates had the lowest effective tax rates.(6) In estates valued between $2.5 million and $20 million, the effective tax rate was approximately one-quarter of the amount of the gross estate.
Small Businesses and Farms Make up Only a Small Fraction of Taxable Estates
IRS data show that farms and small, family-owned businesses make up only a small proportion of taxable estates. Farm property, regardless of size, accounted for about one-quarter of one percent of all assets included in taxable estates in 1997. Family-owned business assets, such as closely-held stocks, limited partnerships, and non-corporate businesses, accounted for less than four percent of the value of all taxable estates of less than $5 million.
Farm and family-owned business assets together accounted for about 10 percent of all assets included in all estates, and less than four percent of the value of all taxable estates of less than $5 million.|
Size of Estate |
Number of Taxable Filers |
Amount of Gross Estate |
Estate Tax After Credits |
Effective Tax Rate |
|
$600,000 - $1 million |
19,006 |
15,315 |
835 |
5.45% |
|
$1 million - $2.5 million |
17,606 |
26,066 |
4,294 |
16.47% |
|
$2.5 million - $5 million |
3,954 |
13,567 |
3,409 |
25.13% |
|
$5 million - $10 million |
1,414 |
9,954 |
2,669 |
26.81% |
|
$10 million - $20 million |
592 |
8,097 |
1,966 |
24.28% |
|
$20 million or more |
329 |
24,649 |
3,465 |
14.06% |
|
Total |
42,901 |
97,650 |
16,637 |
17.04% |
| Source: Internal Revenue Service, SOI Bulletin, Summer 1999. | ||||
Smaller, Family-Owned Business Already Eligible for Favorable Treatment
Family-owned businesses and farms already are eligible for special treatment under current law.
- Under current law, family-owned businesses and farms may be valued in a special way that reflects the current use to which the property is put, rather than its market value. This provision generally reduces the value that is counted for purposes of estate tax; the reduction in value can be as much as $770,000 in 2000. (As a result of the 1997 tax law changes, this maximum reduction in value is indexed annually for inflation.)
To use the special valuation, the decedent or other family members must have participated in the business for a number of years before the decedent's death, and family members must continue to operate the business or farm for the following 10 years. These conditions, along with the $770,000 cap on the value of property subject to the special-use valuation, assure that the benefit goes to relatively smaller businesses and farms that are family owned and operated.
- The amount of an estate that is exempt from taxation is higher for family-owned businesses and farms than for other types of estates. Instead of the $675,000 exemption (rising to $1 million in 2006), the 1997 tax law increased the total exemption for most estates that include family-owned businesses to $1.3 million.
- In addition, when the value of a family-owned business or farm accounts for at least 35 percent of an estate, current law allows deferral of taxation. The tax payable on such an estate may be stretched over up to 14 years, including deferral of annual interest payments for five years, followed by up to 10 annual installments of principal and interest.(7)
If payments are deferred and paid over time in installments, a below-market interest rate of just two percent applies to the tax attributable to the first $1,030,000 in value of a closely held (family) farm or business. There also is a preferential rate on the tax attributed to the remaining value of the family farm or business.
Estate Tax Relief for Family Farms and Small Businesses Can Have Modest Cost
There are a number of ways the estate tax burden could be substantially relieved for these family businesses and farms without repealing or making fundamental changes in the rest of the estate tax. A proposal that Representatives Charles Rangel and others made earlier this year is a case in point.
- The proposal would have raised the exclusion for family-owned farms and small businesses from $1.3 million to $2 million. It also would have allowed the transfer of any unused portion of the exclusion between spouses. As a result, a married couple with a farm or small business interest would receive a $4 million exclusion. (Under current law, a couple can receive a $2.6 million exclusion for a farm or small business interest if they engage in some estate tax planning. The Rangel provision would have provided the $4 million exclusion without the need for estate tax planning.)
- This type of substantial additional tax relief for family owned farms and businesses carries a cost that is only a tiny fraction of the cost of fully repealing the estate tax. This provision would cost about $1 billion a year, compared to the approximately $50 billion-a-year cost of the Archer proposal when fully in effect.
Cost of Repealing Estate Tax is High and Unaffordable
The Joint Committee on Taxation estimates that the Archer proposal to reduce and then repeal the estate tax would cost $104.5 billion over the 10-year period from 2001 through 2010. Full repeal of the estate tax would be effective for people who die in 2010. The full revenue effect from repeal, however, would not be felt until two to three years after that. This is because estate taxes are rarely paid in the year of death; it takes two to three years to settle an estate and file the estate tax return. As a result, the revenue effect of the proposed legislation is not reflected for any year within the 10-year period for which the revenue loss is estimated by the Joint Committee.
Under current law, CBO projects the estate tax will bring in $48 billion a year by 2010. In the 10 years between 2011 and 2020, the estate tax likely would bring in at least $620 billion under the provisions of current law. Full repeal would result in the loss of the entire $620 billion over the 10-year period. The Archer proposal also includes a provision relating to the valuation of capital assets when a person dies that would offset a small portion of the revenue loss from repeal of the estate tax; the offsetting revenue gain is likely to be in the range of $5 billion to $10 billion a year.(8) Thus, the net effect of the Archer proposal when fully phased in would be a revenue loss likely to exceed half a trillion dollars over the 10-year period from 2011 through 2020.
End notes:
1. The full revenue effects of the repeal would not be felt until 2012 or 2013, because there is a lag for settlement of estates and collection of tax.
2. Joint Committee on Taxation, Present Law and Background on Federal Tax Provisions Relating to Retirement Savings Incentives, Health and Long-Term Care, and Estate and Gift Taxes (JCX-29-99), June 15, 1999. As noted in the JCT report, the number of taxable estates filing tax estate tax returns in 1997 is compared to the number of decedents in 1997. In fact, tax returns are not necessarily filed in the year of death.
3. Internal Revenue Service, SOI Bulletin, Summer 1999.
4. Julie-Anne Cronin, U.S. Treasury Distributional Analysis Methodology, OTA Paper 85, September 1999. For most decedents, this income is measured after retirement, when income may be lower than earlier in life.
5. For estates valued between $10 million and approximately $17 million there is a surcharge that phases out the value of the lower marginal rates, which brings the marginal tax rate to 60 percent for estates in that value range. Estates valued at more than approximately $17 million are taxed at a flat rate of 55 percent.
6. The fact that the largest estates have an effective tax rate below all size estates except the smallest may suggest that the largest estates make greater use of estate tax planning and estate tax avoidance techniques. There may be significant opportunity to curb tax avoidance by large estates and use the additional revenues to lower estate tax rates for all estates.
7. The executor of an estate can elect to defer paying the estate tax liability for five years and then pay the deferred taxes in 10 installments. The first installment and the last year of the deferral period coincide, meaning that the maximum extension is 14 years.
8. Capital gains income — the income from the appreciation of assets such as stocks, bonds, and real estate — is not taxed until the income is "realized" — that is, until the assets are sold. If an asset is held until the owner dies, the gain in the value of the asset is never subject to capital gains taxation. The heirs inherit the assets valued at the market price at the time of death and are not required to pay tax on any appreciation that took place during the life of the decedent. The Archer proposal would, for large estates, require heirs to value assets for purposes of capital gains taxation at the original price of the asset. Thus, some additional capital gains taxes would be collected if and when the heirs ultimately sold the assets.
Published in The Jackson Progressive by the kind permission of the Center on Budget and Policy Priorities.
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