Copyright 1999 The Denver Post Corporation
The
Denver Post
August 5, 1999 Thursday 2D EDITION
SECTION: DENVER & THE WEST; Pg. B-09
LENGTH: 769 words
HEADLINE:
Estate tax 'elimination' is shell game
BYLINE: Bruce
Bartlett
BODY:
WASHINGTON - One of the most
remarkable features of the House-passed tax bill is repeal of the estate tax in
2009. The National Federation of Independent Business, a strong supporter of
repeal, hailed this as the "crown jewel" of the legislation. It and other estate
tax foes might not have been so quick to praise if they had read the fine print.
Although the estate tax would indeed be repealed, it would be replaced by
something they may find worse: carryover basis. An important feature of the tax
law as it relates to estates has to do with capital gains. Ordinarily,
realizations of appreciated assets are taxed. Gains on assets held less than a
year are taxed like ordinary income and those held longer are taxed at a maximum
of 20 percent. However, gains on assets that pass through estates are not taxed
at all. When heirs sell an inherited asset, they pay capital gains taxes only on
any gain since they received it. All gains during the life of the person who
originally acquired the asset are forgiven and never taxed.
This
provision of the law is called step-up basis, because the value of an asset for
tax purposes is stepped up at death. It has been a target of tax reformers for
decades. Not only is it unfair, they charge, but step-up also has important
economic consequences. It produces a powerful lock-in effect for wealthy people
late in life. Even if the capital gains tax rate is lowered to 15 percent, as
the House bill also proposes, many such people will never sell their assets if
they can, in effect, get a zero percent rate on assets that pass through their
estates. This creates inefficiency by preventing capital from flowing from
investments with low-profit potential to those with higher potential.
In
1976, Congress sought to fix this problem by instituting carryover basis. Under
this, heirs would pay taxes on gains from the original date of purchase, not
just on gains from the date of death.
Under step-up basis, a share of
stock purchased for $ 10 that was worth $ 100 at death would be free of
capital-gains tax. An heir later selling the stock for $ 105 would pay tax only
on the $ 5 gain since receipt. But under carryover basis, the heir would be
required to pay tax also on the $ 90 gain during the life of the original
purchaser.
Carryover basis never took effect, however, because of
massive administrative problems. It was extremely difficult for executors and
heirs to determine what the original price of assets were since the person who
knew was now dead. Also, carryover basis represented a new layer of taxation on
estates, the estate tax was not abolished. So, in 1978, Congress delayed
implementation of carryover basis and, in 1980, repealed it retroactively. Legal
scholar Lawrence Zelenak calls the short unhappy life of carryover basis "one of
the greatest legislative fiascoes in the history of the income tax."
Now
the House plans to reinstitute carryover basis. Even though the estate tax is
being eliminated, the same administrative problems are going to arise that
killed carryover basis 20 years ago. Moreover, those favoring estate tax
repeal may soon find carryover basis to be worse, because abolition of
the estate tax also will eliminate all the tax avoidance provisions that are now
part of the law. Aggressive use of these techniques can completely eliminate the
estate tax even for large estates. It will be much harder to avoid paying
capital gains taxes if carryover basis is reinstituted.
In effect, what
the House has done is something like the flat tax for estates. All the
exemptions, exclusions and credits that apply to the estate tax are being
eliminated and the rate is being lowered from 55 percent, the top estate tax
rate, to 20 percent, the top rate on long-term capital gains. In fact, this new
tax system will raise exactly as much revenue as the estate tax raises now.
According to the Treasury Department, step-up basis now reduces revenues by $
25.8 billion while the estate tax raises $ 25.9 billion.
Thus for all
the talk about abolishing the estate tax, what the House has really done is just
replace one tax with another raising the same revenue. It may make sense for the
same reasons a flat tax makes sense, but it is not the same thing as abolishing
the estate tax altogether. Those who favor estate tax repeal
need to look carefully at carryover basis. They may like it even less than the
estate tax. Bruce Bartlett is a senior fellow with the National Center for
Policy Analysis, and was deputy assistant treasury secretary in the Bush
administration. This first appeared in the Los Angeles Times.
LOAD-DATE: August 05, 1999