Repeal of the Death Tax: Impact on U.S. Economic Growth

American Council for Capital Formation
February 16, 2000

Introduction

My name is Mark Bloomfield. I am president of the American Council for Capital Formation (ACCF) and I am here today in support of Senate Bill 160, which would repeal Maryland's inheritance tax.

The ACCF is a national organization which represents a broad cross-section of the American business community, including the manufacturing and financial sectors, Fortune 500 companies and smaller firms, investors, and associations from all sectors of the economy. Our distinguished board of directors includes cabinet members of prior Republican and Democratic administrations, former members of Congress, and well-known business leaders. Our affiliated public policy think tank, the ACCF Center for Policy Research, includes on its board leading mainstream scholars from America's most prestigious universities, as well as prominent public finance experts from the private sector.

Madam Chairman, we commend you for this timely hearing on proposals to repeal the Maryland inheritance or "death tax." The central theme of the ACCF's testimony is that repeal of the death tax at both the Federal and state levels can help sustain long-term economic growth, enhance competitiveness, and promote retirement saving.

A substantial body of scholarly research, some of which was sponsored by the ACCF Center for Policy Research, documents that the U.S. tax code treats saving (including retirement saving) and investment very harshly. Since saving is essential to investment and growth, this harsh taxation of saving in the United States works against higher living standards for coming generations and may also impair the economic strength that underlies our world leadership position. In addition, our tax code hits saving and investment harder than does those of many of our international competitors (see tax policy testimony before the U.S. Congress at our Web site, www.accf.org, for background). All of these facts are of increasing concern as globalization continues.

Tax reform can be carried out through a broad-based restructuring in which consumption, rather than income, becomes the tax base, or it can be accomplished through incremental changes to the current income tax base (including repeal of the death tax) that reduce the tax burden on various types of saving and on investment. Either type of tax restructuring would enhance U.S. productivity and economic growth.

Death and the U.S. Tax Code

The U.S. estate tax (or Federal death tax) is simply a wealth tax assessed on the value of wealth at death. As discussed further below, the estate tax is sometimes characterized as a tax on transfers. However, the tax base is wealth itself and it is easiest to evaluate the tax in this way.

Although the history of the estate tax in the United States dates back over 200 years, the current features of the tax were put in place by the Tax Reform Act of 1976. Since that time, the United States has employed three taxes-the estate tax, the gift tax, and the generation skipping transfer tax (GSTT)-which comprise the United Transfer Tax. The logic of the tax system is straightforward. The value of the estate is taxed at increasing marginal tax rates ranging from 18 percent (for a taxable estate of zero to $10,000) to 55 percent (for taxable estate value of $3 million or more).¹ An important feature of the tax, however, is the "unified credit." In effect, this provides a credit against the tax liability associated with the first $675,000 of taxable estate. This has two effects: the first $675,000 of the estate is exempt from tax and the effective marginal tax rate schedule begins at 37 percent. Because all interspousal transfers are exempt from tax, each spouse, in effect, takes the unified credit in succession, leading to a total exemption of $1.35 million of estate value.

Not only does the death tax raise relatively little revenue (in 2000 it is projected to generate about $30.5 billion, or less than 2 percent of federal tax receipts from approximately 50,000 estates that are subject to the tax²), it also generates considerable criticism. Proponents of the tax argue that it is too easy to avoid and insufficiently aggressive in redistributing resources, while critics highlight its sizeable marginal tax rates, economic distortions, and potentially perverse distributional consequences.³

As Professor Douglas Holtz-Eakin, chairman of the Department of Economics at Syracuse University, states, the estate tax is a tax on capital accumulation, with the tax base the individual's accumulated wealth (after appropriate deductions and exemptions). Accordingly, the greater the individual's accumulation, the larger the tax liability.⁴ By implication, the estate tax lowers the return to saving. An individual who starts with $25,000 and earns an average return of 15 percent over 30 years will accumulate in excess of $1.6 million. A simple 50 percent estate tax reduces the net accumulation to just over $800,000, which is equivalent to lowering the annual return to 12.4 percent. For this reason, the impact of the estate tax is conceptually similar to the impact of all taxes levied on capital income. In this example, it is tantamount to an additional tax of just under 20 percent on the annual return to capital.

In addition to Professor Holtz-Eakin, many top academic scholars including University of Chicago Nobel prizewinner Gary Becker, Harvard University Professor of Economics Gregory Mankiw and other economic policy experts, conclude that the estate tax should be repealed or reduced because it adds to the already heavy U.S. tax burden on saving and investment. For example, analysis by MIT's James Poterba shows that the U.S. estate tax can raise the cost of capital by as much as 3 percent. The estate tax also makes it harder for family businesses, including farms, to survive the deaths of their founders. A recent ACCF study, compiled by Arthur Andersen LLP, surveyed 24 industrialized and developing countries and shows that the top U.S. federal marginal death tax rate is higher than that of all other countries surveyed except for Japan. (See Figure 1 and ACCF special report, An International Comparison of Death Tax Rates; also, Japan has recently proposed to lower its top marginal death rate tax rate of 70 percent.) Death tax rates imposed on estates inherited by spouses and children average only 21.6 percent for the 24 countries in the study, compared to 55 percent in the United States. (Tax rates are often higher on assets inherited by more distant relatives or by non-relatives.) Seven countries-Argentina, Australia, Canada, China, India, Indonesia, and Mexico-have no death or inheritance taxes. The average marginal top tax rate in the 17 countries with a death tax is only 30.5 percent, which is slightly more than one-half of the U.S. top federal estate tax rate. Not only are U.S. death tax rates higher than those in most of the industrialized and developing world, but the value of the estate where the top tax rate applies is lower. The average value of the estate where the top tax rate applies is over $4 million compared to only $3 million in the United States.

Figure 1	International Comparison of Top Marginal Death Tax Rates
Source: An International Comparison of Death Tax Rates (Washington, D.C.: American Council for Capital Formation Center for Policy Research, June, 1999).

Of particular importance to this hearing today is the recent analysis by Professor Holtz-Eakin of the impact of the death tax on a specific state. This, in fact, is the first time where we have empirical data on the impact of the death tax on a state's economy (see ACCF special report summarizing previous work by Professor Holtz-Eakin, The Death Tax: Impact on Investment, Employment, and Entrepreneurs). Professor Holtz-Eakin analyzed the impact of the current federal death tax on capital accumulation, saving, capital costs, investment, and employment.⁵ First, using a sample of data collected by the Public Policy Institute of New York State in May, 1999, Professor Holtz-Eakin notes that there is a negative relationship between anticipated death tax liability and growth in employment, particularly for growing firms. His analysis suggests that at least 15,000 jobs will be lost in New York state over the next five years due to the effect of the estate tax on small firms. Second, the death tax reduced U.S. annual investment by sole proprietors in the range of 2 to 10 percent or almost $45 billion in 1996. Third, the death tax hits hard at entrepreneurs; of the total number of people liable for the federal death tax, 48 percent are entrepreneurs. Professor Holtz-Eakin states that the death tax should not be viewed as hitting all savers equally. Instead, the tax hits especially hard at entrepreneurs who are trying to put money into their business. For these individuals, their saving is their investment.

What is the bottom line? Professor Holtz-Eakin's pioneering macroeconomic analysis represents an important step toward buttressing the large, anecdotal evidence on the detrimental economic impact of the death tax. Viewed in isolation, this study suggests large behavioral effects from the estate tax. Taken in conjunction with the analyses of Nobel prizewinner Gary Becker, Professor Mankiw, and others, it makes the economic case against the death tax.

Conclusion

The new data presented here suggest that the estate tax is shifted-forward in time to the business operation and onto factors of production (capital and labor). Since most studies suggest that the labor supply bears the incidence of labor taxes and that slower capital accumulation hurts productivity and real wages, this suggests that the estate tax on "rich and dead" small business owners and entrepreneurs may be in part paid by their far-from-rich and very alive employees. Repeal of state as well as Federal death taxes would be a positive step in promoting and maintaining U.S. investment, employment, and economic growth.  

Notes

1. Because the "benefits" of the initial, lower tax rates are phased out, the effective marginal tax rate reaches a maximum of 60 percent.

2. See Joint Committee on Taxation (1998). Indeed, Bernheim (1987) suggested that the tax is actually a net revenue loser because of the interaction with the charitable deduction of the individual income tax.

3. McCaffery (1994) is an especially prominent critic.

4. Douglas Holtz-Eakin, "The Death Tax: Investment, Employment and Entrepreneurs," Tax Notes, August 2, 1999.

5. Holtz-Eakin, "The Death Tax."

References and Additional Reading

Bernheim, Douglas. 1987. Does the Estate Tax Raise Revenue? In Tax Policy and the Economy, ed. Lawrence Summers. Cambridge, Mass.: MIT Press, 1:113-138.

Carroll, Robert, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen. Forthcoming. Income Taxes and Entrepreneurs' Use of Labor. Journal of Labor Economics.

Carroll, Robert, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen. 1997. Entrepreneurs, Income Taxes, and Investment. Paper presented at conference, Does Atlas Shrug? The Economic Consequences of Taxing the Rich, 24-25 October 1997, at Office of Tax Policy Research, University of Michigan Business School, Ann Arbor, Mich.

Gale, William and Maria Perozek. 1999. Do Estate Taxes Reduce Saving? Brookings Institution, Washington, D.C. Mimeo. April.

Davenport, Charles and Jay A. Soled. 1999. Enlivening the Death-Tax Death-Talk. Tax Notes 26 July: 591.

Joint Committee on Taxation, U.S. Congress. 1998. Present Law and Background Relating to Estate and Gift Taxes. 105th Congress, 2d session. 27 January.

Juster, F. Thomas and Richard Suzman. 1995. An Overview of the Health and Retirement Study. Journal of Human Resources 30: S7-S56.

McCaffery, Edward J. 1994. The Uneasy Case for Wealth Transfer Taxation. Yale Law Journal 104(2).

Poterba, James. 1997. The Estate Tax and After-Tax Investment. NBER Working Paper No. 6337. Cambridge, Mass.: National Bureau of Economic Research. December.

Public Policy Institute of New York State (PPINYS). 1999. Survey of the Impact of the Federal Estate Tax on Family Business Employment Levels in Upstate New York. Prepared by Travis Research Associates, Inc.

Soldo, Beth J., Michael D. Hurd, Willard L. Rodgers, and Robert B. Wallace. 1997. Asset and Health Dynamics Among the Oldest Old: An Overview of the AHEAD Study. The Journals of Gerontology Series B: Psychological and Social Sciences 52B: S1-S20.