Can the Estate Tax Solve the Fiscal Cliff?

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Warren Buffett is one of the wealthy signatories of Responsible Wealth's robust estate-tax proposal.

The battle over the fiscal cliff so far has revolved around income taxes for the wealthy and entitlement reform. But there are many other ways the federal budget deficit could be trimmed that haven’t received much of the spotlight recently, and one of those is the estate tax.

The estate tax has gone through many changes over the past 10 years, as the tax cuts enacted early in President George W. Bush’s first term reduced the rate Americans pay on inheritances and raised the threshold amount under which estates are exempt from the tax. It was briefly repealed altogether in 2010 before being re-enacted in a 2010 compromise that set the estate-tax rate at 35% for estates valued at more than $5 million ($10 million for a couple), indexed to inflation.

But without congressional action, the estate tax will revert to its pre-2001 form Jan. 1. Under that version of the law, estates valued at over $1 million were subject to an estate tax on a graduated basis from 37% to 55%, and a 5% surtax was imposed on some estates valued at over $10 million, which would eliminate the benefit of the graduated rate for very large estates.

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Now that the fiscal cliff debates are (we hope!) coming to a conclusion, Responsible Wealth — a network of business leaders and other wealthy citizens, including Bill Gates Sr., Warren Buffett and George Soros — is speaking out in favor of returning to an estate-tax structure more reminiscent of that of the pre-Bush years. In a telephone press conference this morning, the group made the following statement:

We believe that our country should have a strong tax on the largest estates. We believe that a well-funded government benefits people at all economic levels and that our families have benefited significantly from government investment in schools, infrastructure, research, technology, public safety, national defense, laws and regulations.

The group is arguing for a much lower exemption — $4 million for a couple — than current law dictates. Its members also believe that the tax rate should begin at 45% and rise on a graduated basis in proportion to the size of the inheritance. This is actually a more liberal policy than President Obama is calling for; he has proposed a maximum estate-tax rate of 45%, with a combined exemption for couples up to $7.5 million.

But how much money would this tax actually raise, and could it help avert some of the other painful choices being made in the fiscal-cliff debate? The amount the estate tax could raise, of course, depends on the details of the reform. According to a recent analysis by the Wall Street Journal, current policy, which mandates a maximum estate tax of 35%, would raise $161 billion in revenue over the next 10 years. By contrast, reverting to a pre-2001 estate tax would raise $532 billion in the same time period, while the President’s proposal would raise $276 billion. 

These aren’t the kind of proposals that are going to solve America’s budget issues overnight. The U.S.’s yearly deficits have been topping $1 trillion per year. At the same time, every hundred billion counts, and the past several months (and perhaps the entire election cycle) have been centered on whether the Bush income-tax cuts on top earners should expire — a debate over a swing of just $110 billion (more or less) in taxes over the next decade, according to the Congressional Budget Office. And if an aggressive estate tax would raise almost $400 billion more in the next 10 years than current law allows, that’s $400 billion less we would have to cut from entitlement programs.

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These figures raise the question of why the estate tax wasn’t been a larger topic of debate during the election or the fiscal-cliff negotiations thus far. These taxes affect a very small portion of American society — just 4,000 people, under the current policy — and almost all of these folks are very wealthy. It’s the most progressive section of the tax code, and reverting to pre-Bush estate-tax policy would raise more than twice the amount as reverting to pre-Bush income tax policy. So why haven’t we heard more about it?

One reason is that there is serious Democratic opposition to expanding the estate tax. Senators Mary Landrieu of Louisiana, Max Baucus of Montana and Mark Pryor of Arkansas, all of whom are up for re-election in 2014, publicly opposed raising the estate-tax rate.

But their opposition is probably just a reflection of the public’s general distaste for a robust estate tax, which, almost regardless of one’s political leanings or position on the issue, has a confiscatory feel to it. As Kevin Hassett of the right-leaning American Enterprise Institute has noted, the estate tax isn’t all that popular with Americans in general. In a 2010 poll, 56% of Americans responded that passing legislation preventing a significant increase in the estate tax should have been the most important priority for that lame-duck Congress. This ranked above issues like ratifying a nuclear-arms treaty with Russia and ending “Don’t ask, don’t tell.” “This is fascinating because few, if any, of the respondents would ever have to pay the estate tax,” Hassett writes. “The best explanation is that Americans, and especially conservatives, are wary of a government that has no respect for the basic right of an individual to dispose of his hard-earned wealth as he sees fit.”

Sure, some of this is standard-issue conservative opposition to taxes. But I think many people of all political persuasions recoil when they see headline rates of 55%. We seem to widely feel that nobody, no matter how rich, should have to fork over more than half of their wealth when they die.

On the other hand, it also seems true that many Americans dislike the tax because they don’t understand it. The large deductions of the estate tax mean that few estates end up paying anywhere near those headline rates. And as one of the wealthy signatories on the phone call this morning, Vanguard Group founder Jack Bogle, said, the tax’s best selling point is its progressiveness. The U.S. is obviously in a fiscal crunch that can’t be solved simply by cutting services, argued Bogle. Taxes will be part of the equation, and “if [the wealthy] don’t pay it, somebody else will,” he said. “We have to explain to people that those who have the most resources to bear the burden have to step up to the plate.”

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