Originally published in The Boston Globe
Tuesday, February 27, 2001

Estate tax repeal makes sense
By Martin and Kathleen Feldstein

A majority of Americans support President Bush's proposed repeal of the estate tax despite the fact that only a relatively small proportion of estates pay any estate tax at all. That's probably because most people recognize that the estate or death tax is just plain unfair. Its an extra tax levied on income that has already been taxed before death and people dont like double (or triple) taxation: taxing income when its earned, taxing the interest and dividends on the income that is saved, and then taxing the accumulated amount when the individual dies.

While the estate tax accounts for less than one-half of 1 percent of federal tax revenue, the tax rate itself is punitive, with a top rate of 60 percent on estates of more than $3 million. When combined with the income tax levied on IRA and 401(k) withdrawals at death, the government takes more than 75 percent of every extra dollar of accumulated wealth. This incredibly high marginal tax rate can hit people with quite moderate incomes who have accumulated sizable estates, thanks to IRAs, 401(k)savings plans, and the stock market.

Consider someone who saves $6,000 a year through a combination of his own IRA savings and the 401(k) contributions that he and his employer make. Accumulating such funds from age 30 and investing them In a diversified portfolio of stocks would generate assets of $3.5 million for a current 65 year old, even with no other savings and without owning a home. If he dies at age 65 without a living spouse, the entire accumulation would be subject to both income and estate taxes. The amount that passes to his children and other beneficiaries would shrink from $3.5 million to less than $1.4 million.

The high rates of estate tax were put in place 65 years ago in the midst of the Depression when income tax rates were raised to 79 percent. Such penal rates are no longer acceptable to the American public. Last summer, the House and Senate passed legislation to eliminate the estate tax over the next 10 years. Although President Clinton vetoed that legislation, President Bush has made the elimination of the estate tax a central part of his overall tax plan.

Its ironic to observe some of the opposition to repealing this tax. Some of the richest Americans's - Warren Buffet, Bill Gates, and George Soros - say it would be bad for the economy and would be very costly. Thats easy for them to say since they have enough resources to provide handsomely for their own heirs even with the current system. But the charge they make is wrong on both counts. The estate tax has such a distorting impact on economic behavior that repeal might actually mean no loss of government revenue.

Professor Joel Slemrod of the University of Michigan and his colleague Wojciech Kopczuk have recently completed a large empirical study on the disincentive effects of the estate tax. They conclude that the estate tax has a negative effect on the incentive to work and to save and that it creates wasteful tax avoidance. Knowing how high the tax rate will be on their future bequests, people react by spending more now, working less hard to accumulate savings, and seeking ways of avoiding the tax.

When people work less or save less they hurt not only the economy, but also reduce the governments tax revenue. And its not uncommon to hear people say that they prefer to contribute their money to charity rather than to give it to Uncle Sam in the form of estate taxes. When individuals are induced by the estate tax to give money to charity the government loses income tax on the charitable gift, loses estate tax revenue (because charitable gifts are deducted from the taxable estate), and then lose the future tax revenue on the interest and dividends and capital gains on the contributed amounts that shift to nontaxable foundations and other charities. When all of these pieces are put together, the net effect may well be to offset fully the revenue loss that the official score keepers say would result from eliminating the estate tax.

Of course, were not opposed to charitable giving. But we think that an estate tax that essentially penalizes people for not giving to charity cannot be justified.

Were also not persuaded by those who argue that states would lose revenue if the federal estate tax is repealed. Those who make that argument note that states now receive a share of the federal estate tax revenue with no extra cost to the taxpayer. Of course, taxpayers dont resist that state tax because it costs them nothing extra. If the federal tax were repealed, states would be forced to lose some or all of their estate tax revenue because experience shows that wealthy older individuals move to tax friendly states when their original states try to take more in death taxes than the amount that they get from the federal government. Fortunately, this argument is about a trivially small amount of money for the states. The total estate and gift tax revenue that states currently collect is less than 2 percent of their overall tax revenue.

The removal of the estate tax is good economic policy. It eliminates an extremely high marginal tax rate that discourages work and saving and that induces enormous amounts of effort at tax planning and tax avoidance.

Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.