Why the GOP Should Oppose the Death Tax

FF Symposium: Traditionally, conservatives have argued for repeal of the estate tax, characterizing it as an unfair “double tax.” FF Contributor Cetulus however argues for conservatives to back the estate tax as an alternative to high marginal income tax rates. Brian Domitrovic, author of Econoclasts, however responds that the estate tax would only discourage work and investment.

In the waning moments of F. Scott Fitzgerald’s novel This Side of Paradise, the young, broke hero Amory Blaine is trying to convince a plutocrat of his acquaintance that socialism should be given a good try. Why? The rich are by nature competitive, Amory says. If you replace money as the prize for hard work with, say, fancy ribbons, the rich are so ambitious that they’ll sweat for them just as much, and you can distribute money across society as you like. Amory had seen as much at Princeton, where the boys would step on any head for the tiniest collegiate perquisite or honor. Finally the plutocrat has to wave it all off: “Men won’t work for blue ribbons, that’s all rot.”

The rich, however, will work like the dickens if the only serious tax they’ll ever face is a confiscatory death levy, according to FF contributor Cetulus. I read Cetulus and think, “He who dies with the most toys loses.”

Cetulus is dead on in marveling how the Republicans hold forth against the estate tax on grounds of fairness. Fairness is the purview of John Rawls and the progressives. You’ll never beat them at their own game. The Republicans’ game must be economic growth and opportunity – not to mention rights to property.

Cetulus adduces a Park Avenue home bought in 1960 for $20,000 and left to heirs today with a value of $10 million. With no estate tax along with the “stepped-up basis,” the heirs get a $10 million boon. There is the not inconsequential matter that the price level has increased seven and a third times since 1960, plus that of the various expenditures over the years against depreciation and for capital improvement, both things increasing the real basis of the purchase price. In addition, who says that the house – of such enormous value and owned presumably by someone self-made – did not serve as collateral in some business enterprise of the owner’s over the years? If that business enterprise realized profit (or employed workers subject to payroll or income taxes), the house (which functioned as capital) was worked over for federal tax revenue. Its value has already been taxed. In this case, the stepped-up basis for the heirs actually would be insufficient. The basis should be greater than $10 million.

As for gifts, one of the reasons none of us ever seems be given a billion dollars tomorrow is that even though we would pay no tax on the gift, the donor would be liable for tax. Fans of the Whitewater scandal will recall the shenanigans played with loan forgiveness on the Clinton tax returns in Arkansas days.

The heart of the matter is Cetulus’s claim that the estate tax is the only way to achieve rough tax justice in our society. Otherwise, the great source of “income” of the young rich – inheritance – will go untaxed, while the working poor slave away under payroll rates that themselves are greater than the maximum rate on capital gains. This is where we need to recall one of the greatest theoretical accomplishments of supply-side economics. Readers who wish for more along this line are encouraged to look at my book on the history of supply-side economics, Econoclasts.

Norman Ture, an economist who did crucial consulting work for Congress in the service of Jack Kemp’s tax-cut bills in the 1970s (and a Treasury official under Reagan), also devoted time to a model of what an optimal tax system would look like. Ture said that the amount subject to taxation should be that portion of an individual’s income every year that is not reflected in the increase in the individual’s net worth.

Let’s say in one year, your home appreciates in value by $50,000, your investments make the same amount, you earn $100,000 on your job, and you get an $800,000 inheritance. Your income has been $1 million. How much did your net worth increase? By, say, $750,000, if aside from consuming all your salary, you also bought a sports car and took some vacations by drawing on the inheritance? You are taxed (at a low, flat rate, of course) on $250,000 – income minus your increase in net worth.

Ture’s model gets around precisely the problem Cetulus identifies. The heirs who get the $10 million inheritance tax-free because of the lack of a death levy and the stepped-up basis find that they will get taxed as soon as they act rich. As soon as these rich kids start taking the trips to Bermuda, hitting Chanel, and ponying up for the clubs, the income minus increase in net worth calculation manifests itself to the IRS. Stop Acting Rich, as one of the business bestsellers implores us.

You can quibble that net worth calculations are too burdensome for the whole population. Yet this only begs the question of the clarity of the rate code to begin with. (Click here for an update of Ture’s model.)

If Republicans are acting strangely for warring against the estate tax on fairness criteria, we can also marvel at those who do so in view of government revenue. The income tax hauls in fifty times that of the estate tax. Kill it, and you’d have to raise marginal rates less than one percentage point for revenue neutrality. Clearly, efficiency is what is lost given a high estate tax. Cetulus essentially gives the game away in saying that the rich will find their income tax-deferred given lower marginal rates in exchange for a high death tax. Not the rich per se, but the self-made will find that it behooves them abruptly to change course halfway through life, so that they stop accumulating and start spending.

Yet it is precisely those who have proven adept at saving, investing, and succeeding in new businesses who we would like to see unimpeded in the same vein.  If with every heartbeat, such persons get closer and closer to a mega-tax on the profits of these activities, they will certainly come to curtail them and seek to dissipate or hide the profits. Why fool with killing the goose that lays the golden egg – of entrepreneurialism, business formation, and job growth?

Studies (such as here) of the estate tax have shown that returning to the old rate north of 50% would result in $2 trillion less in gross yearly reported estates. The lost $2 trillion represents both money entrepreneurs will spend and otherwise forsake from making in view of the estate tax, as well as the efforts undertaken (at great expense) to shield inheritances from the code. The efficiency, output, and employment consequences for the economy will be very high if we bail out to a high tax on estates – unless, of course, the self-made are so motivated that all they really care about is the thrill of the chase, or little blue ribbons.