it comes in pints?

Estate Tax II

Following up on this post, here are my additional arguments. As far as I can tell, these are original with me, though I am sure someone has made them before and probably more eloquently. Please feel free to direct me to any links which have made them before, I would be very much interested in reading them.

1. It's tacky to tax death

Okay, that's not much of an argument but tackiness is a good place to start. Opponents of repeal routinely accuse "right wingers" of having invented the term "death tax" as a rhetorical device. But right on the very first page of IRS Form 706 are:

Line 13: "Credit for state death taxes"

Line 16: "Credit for foreign death taxes"

Rare and shining examples of honesty in government. And really, is there a more accurate way to characterize a tax on a person's assets collected at their death (assets already likely taxed as income) than as a "death tax"?

Add to this the estate tax's little brothers, the Gift Tax (lest someone give away their property before they die) and the Generation-Skipping Transfer Tax (lest any generation escape taxation on its death - no, that is not a joke), and tackiness abounds.

Now add the litany of assets required to be catalogued and appraised (formally or informally). Take a look at Form 706 (warning before you click - it's a 2MB pdf file) and its instructions for the nine (count 'em, nine) separate schedules for taxable assets. Prepare to be appalled at the level of sheer, niggling detail.

Top it off with more variations of death taxation: Life insurance is taxable and even has its own separate Form 712. This form is specifically mentioned for four separate schedules: for insurance on the decedent's life (if the policy is "owned" by the decedent), for policies for which the decedent is the beneficiary (yes, it get taxed before the insured even dies), and as a separate listing for "Jointly Owned Property" and "Transfers during Decedent's Life".

Tacky doesn't even begin to describe it.

2. It is an estate tax, not an inheritance tax

This strikes some people (nearly everyone I talk to, in fact) as a distinction without a difference, but philosophically and practically, there is a huge difference. Nearly every supporter of the tax mentions the unfairness of

rewarding heredity rather than merit. In Mr. Buffett’s colorful analogy, repealing the estate tax for the benefit of heirs of the rich would be like choosing the nation’s Olympic team from among the children of past Olympic champions.

Even conservative commentator Stuart Buck falls into this trap:

After all, income is earned, while inheritances are not. Why penalize productive activity (work) while rewarding the accident of birth?
[…]
Our tax system generally taxes any transfer from one person to the next...If the dead guy had decreed that all his estate be spent at Wal-Mart, the sales tax would still apply, because that would be another transfer. So when the estate is transferred to the dead guy's children, that too is another transfer to which federal taxes ought to apply.

We'll leave aside the differences in rates between sales and estate taxes (or income and estate taxes for that matter). We'll also leave aside Jane Galt's eloquent explanation of why estates should exist in the first place.

Even if one accepts (and I don't) the argument that it is fair to tax inheritances, this is not what happens. The estate tax is neither an "income tax" nor "transfer tax". It is a tax on assets before any transfer or distribution takes place, i.e., on the largest possible aggregation of assets. Philosophically, this is punishment for failing to spend one's money quickly enough. Worse, it is a bald-faced denial of property rights, a direct statement that the government owns your property and merely allows you to use it during your lifetime with no control over what to do with it after.

No doubt, some readers are still not convinced that it matters, so let's take a concrete example to illustrate the practical difference. Suppose that Millionaire Joe has a $100 million estate he leaves to his one kid. Kid gets $1.5 million (this year) outright and pays 43% and up on the rest of the money. In this case, it matters little whether there is an estate tax or inheritance tax. But what if Joe has two kids? Three? Ten?

Take it to extremes: Joe decides to be a minor philanthropist and bequeath $100 each to a million different poor people. With an inheritance tax, each gets $100 free and clear. But with the estate tax, every single one of those people has been taxed at the same rate as Joe's kid. No matter how you feel about spoiled rich kids, the estate tax does absolutely nothing to advance the "lofty goals" of its supporters.

3. Small estates are more likely to have a single major asset

It is also very likely that the asset will be illiquid - a farm or small business. Previous arguments about this point centered on the hemorrhage of cash that could otherwise be used to expand the business, but I will make some additional observations.

First observation: People hit by the estate tax are at the mercy of price fluctuations in real estate and business markets. Face it, price bubbles happen not only in stocks but in business prices and real estate. Such fluctuations normally mean absolutely nothing unless you want to sell the asset. If my neighbor is stupid enough to pay too much for the vineyard next to my farm, that's his problem (not a hypothetical example, this is exactly what caused a huge bubble in rural land prices in the SF Bay Area back in the 70s), but it raises the market value of my farm, which means absolutely nothing to me if I don't want to sell. But should I die at the wrong time, my estate would be taxed as if I wanted to sell it right then. And if the market goes back to its pre-bubble value, my heirs don't get their money back (there actually is a provision to value the asset at either date of death or six months after, but even the most rapid crashes have a timeframe longer than that).

Much like those people who are considered "rich" because their house has risen in value, that value means nothing until I can sell it and spend the proceeds. Or in this case, until the government decides I will be taxed on it. Usually, I have some control over the timing and can ride out market fluctuations, but I have little control over death and if I really don't want to sell the asset, I should not be victimized by those fluctuations.

Second observation: There is also a nasty little provision of the tax code to the effect that the appraised value of the property is to be for the "highest and best" (read: "most profitable") use of the property. This "highest and best use" is absolutely unaffected by what I want to do with the property. If I own one of the few (if any) remaining farms in the San Fernando Valley, my estate is not taxed on what that property is worth as farmland nor what I could sell it for as farmland, but on what I could get for any other purpose (read: "subdivisions" and "office buildings"). Again, it has nothing to do with what I do or want to do with the property, but what I could conceivably sell if for whether or not I want to.

Third observation: People who like the estate tax tend to like open spaces and hate urban sprawl. It takes some serious cognitive dissonance to refuse to recognize that forcing people to sell farms to pay estate taxes very likely means more urban sprawl and fewer open spaces. Oh, and the same people also tend to hate corporate hegemony:

4. The estate tax leads to corporate hegemony

Assume that my farm isn't filled up with condos and convenience stores, but remains farmland. Alternatively, assume that, instead of a farm, I had a modestly successful business that doesn't generate enough cash to pay the estate tax outright. My heirs are forced to sell all or part of the farm or business. Who will they sell it to?

It's a pretty good bet they won't sell it to poor people. Poor people don't have money. That's what makes them poor. If the poor people could buy it, they would already be rich (without even using the Democratic Party's definition of "rich" as "has a job").

Duh. Double duh.

In fact, it is highly likely that the person who buys it already has a lot more money than my family has, probably enough to be able to spend the money required to buy it without putting a crimp in their lifestyle. This is why a large chunk of California grazing land that once belonged to my great-grandfather now belongs to a rich guy who lives in Boston (it was not the estate tax but the Great Depression that removed the property from the family, but it was still a rich guy who ended up with it).

And if it's not a rich person who buys it, it will be one of those EvilCapitalistCorporations. In fact, if the entire purpose of the estate tax is to break up giant estates and it actually becomes effective at doing so, it follows that ultimately corporations will own everything. Think about it: no one gets out of here alive but corporations are forever (or might as well be). No matter how many shares of corporate ownership are spread thinly among the population, the corporation survives. Every person is equally rich (or poor) and only pooled money in the form of corporations can actually own any significant asset.

I really don't think this is what the tax's proponents want (or maybe it is...see the discussions about Buffett, Soros, et al., in the previous post).

5. The tax has never been indexed

The estate tax was instituted in 1916. The current version dates from (IIRC) 1927 (and that might not even have been a major revision). Since then, the tax has never been indexed for inflation. The rate brackets are the same as they were 75 years ago. There have been some recent changes - the rates have been tweaked a little bit (top rate down from 55% to 48%, etc.), the exclusion has been increased...

Oops. That's not correct. In actual fact, there is no exclusion after the first $10,000. The tax begins at a rate of 18% for estate value in excess of $10k, increasing quickly to 26% over $60k (roughly the median yearly salary for the country), continuing to increase to 45% over the current "exclusion" of $1.5 million, thence to 48% for all value in excess of $2 million.

That look in your eye tells me you think I'm full of crap. Often so, but not in this case. This is the law as it currently exists (see page 4 of the Form 706 Instructions if you still don't believe me). All that blabber about the "exclusion" being raised is simply not true.

What has increased is a little tax credit number on Line 9: "Maximum unified credit against estate tax", which for people dying in 2004 is $555,800. You see, Congress didn't change the underlying law (aside from tweaking some rates). They didn't change the brackets. They didn't even change the value of assets "excluded" from the estate tax. They changed the "credit" you are allowed to subtract from the "Gross Estate Tax" on Line 8. Another distinction without a difference? Well, maybe. The lawyers and accountants could say for sure. But I find it fascinating in a "look at that brick wall coming at me really fast" sort of way that this is the way the law was "changed".

In any case, amount of tax owed is being gradually decreased until 2010, when there will be no estate tax collected on any size estate. The following year it comes back with a vengeance, returning 2002 levels ($1 million "exclusion" and a top tax rate of 50%).

Not worried? Don't feel like a millionaire? Think you don't have to worry? Think again. Just as many people are starting to bump into the Alternative Minimum Tax, which hasn't been indexed since the 1960s, a whole lot of regular, middle-class people are going to realize:

6. The Estate Tax: It's not just for rich folks anymore

For most middle-class people, the largest single asset they own is their house. The median house price in my area (SF Bay Area) is currently just around $647,000, up 15% over 2003. In fact, it is instructive to take a look at this site to get an idea of how quickly house prices are rising all over the country. Then extrapolate those price increases into 2011 - that's less than seven years away. It's not pretty.

But, you say, you can't have too much sympathy for people whose property increased to give them unearned "profit". They didn't work for that increase, right? Well, consider those people who have to buy at those inflated prices. They are or will be out of pocket that amount. Should they die young, before their property has had a chance to earn that unearned "profit", it's all earned money they are being taxed on (minus, of course, a probably monstrous mortgage).

Still not concerned? Consider a few other new facts of the modern world:

Retirement pensions are on their way out. Used to be that a company, union, or whatever, kept a large amount of money invested, paying pensions to retirees out of the investment profits. Maybe that's still the norm in the public sector and some of the large, old-time companies. But more and more, retirement is becoming a personal thing, with 401k's, 403b's, Keoughs taking the place of the old pensions. That's generally good; I like that people can take ownership and control of their own lives, and I like that the laws allow for tax-deferred accounts to do it. Sure beats knowing that you'll never get your investment back from Social Security.

BUT GUESS WHAT, KIDS!

All that hard-earned money that you socked away for your retirement will be subject to the estate tax. Take a moment right now (or perhaps you've already done it) to do a quick estimate of how much money it will take to retire comfortably. I'll wait.

Now assume you get hit by a bus right after you've retired. Where is your money (and it is, in fact, your money) going to go? Do you, a simple middle-class wage slave who put money away for a rainy day, feel like one of those super-rich fat cats the lefties love to hate? Do you feel like you're on your way to a family dynasty?

I didn't think so.

And consider this: All that money in your 401k (or any other annuity-type vehicle) is subject not only to the estate tax, but to income tax as well. That's right, if your kids get it over your dead body, it will be taxed twice because, of course, you haven't yet paid income tax on it. Now, on the face of it, this sounds reasonable - you didn't pay the income tax when you earned it, after all. But the estate tax, with its very much higher rates, takes the first bite out of the pile. Then comes the income tax, which, by the way, will probably be taxed as if your kids took the entire distribution as income in one year (some vehicles may be spread out over five years; certainly it will not be spread out over the entire time it would have had you lived a long, full life). Note that I said the entire distribution because, you see, the full amount (not just what's left over after the estate tax) is taxable as income - but being the kind, gentle, eminently fair souls they are, the government allows your kids to deduct on their income tax returns the amount of additional estate taxes incurred by the distribution. It's difficult to say for sure, but since your kids are likely in their prime earning (and high-tax-bracket) years, while you would have been in your lower-tax-bracket retirement years, the government probably took a much larger chunk of your money than if you had gotten to enjoy it yourself.

Are you ready yet to drink yourself into oblivion? I know I am. But before you pass out, tell a friend and maybe, just maybe, we can either kill this outrageous theft or at least get it back to where it will affect only those it was originally intended to affect: the ones rich enough to afford to get out of it.

Posted by Ken S at September 21, 2004 06:25 PM | TrackBack (2) |