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CONSAD Report Executive Summary

THE FEDERAL ESTATE TAX:

AN ANALYSIS OF THREE PROMINENT ISSUES

In recent years, repeal of the federal estate tax has become an increasingly prominent legislative topic. Several contentious issues have emerged in the controversy over its potential repeal. CONSAD Research Corporation has analyzed the empirical evidence relating to three of the most salient issues.

The Prevalence of Family-owned Businesses in Taxable Estates

Some critics of the proposed repealing of the federal estate tax have asserted that "Less than one percent of taxable estates are comprised of family-owned businesses." This fallacious assertion is based on an extremely restrictive definition for a family-owned business.

When more realistic criteria are used to define the financial attributes of an estate that includes a family-owned business, the summary data that the Internal Revenue Service (IRS) has compiled from estate tax returns reveal that more than 25 percent of the total value of taxable estates consists of the value of business assets. In addition, almost 20 percent of estate tax returns were filed for people who reported that their occupational group was "executives, managers." The surviving spouses of people from that occupational group likely filed a comparable number of returns.

The data reported by the IRS do not permit more specific determination of the nature and composition of taxable estates. Nevertheless, the data clearly indicate that the assets of family-owned businesses are sizable portions of the estates reported on a substantial percentage of taxable estate tax returns. Rather than being less than 500 in a typical year, the total number of taxable estates that consist largely of family-owned businesses likely exceeds 10,000 annually.

The Vulnerability of Family-owned Businesses to Estate Tax Liability

due to Liquidity Problems

The vulnerability of a family-owned business to its owner’s estate tax liability depends on the liquidity of its assets. When assets cannot be readily transformed into cash, the ability of their owners to prepare adequately for payment of the tax (e.g., by purchasing term life insurance) is restricted, and the likelihood that it will be necessary to sell part or all of the businesses when the owners die is increased.

Data published by the IRS indicate that partnerships operating food stores hold approximately 60 percent of their assets in the form of physical inventories, buildings, and equipment. That value is higher than the percentage in any other industry sector, and is more than twice as large as the value for all industries in total. Large percentages are also observed for the manufacturing, transportation and public utilities, and other retail trade sectors. If the value of land is taken into account, farms are shown to have vulnerability to the estate tax also.

Similar differences in liquidity are indicated by the composition of the liabilities that are reported for different industry sectors. Among food stores, farms, and the construction, wholesale trade, and other retail trade sectors, large percentages of their liabilities consist of accounts payable and mortgages, notes, and bonds payable. The largest sectoral percentages are approximately twice as large as the percentages for all industries in total.

Overall, the data indicate that food stores and farms have less liquidity, in general, than do businesses in other industry sectors. Their relatively low liquidity makes food stores, farms and, to a lesser degree, businesses in a few other industry sectors more vulnerable to sale for payment of the estate tax than other family-owned businesses would be.

 

The Aggregate Economic Effects of Repealing the Estate Tax

Repealing the estate tax would free up resources for alternative purposes. The heirs of people who die would inherit additional funds that otherwise would have been collected as taxes. Also, the resources that people now expend (e.g., for term life insurance) to mitigate the consequences of the estate tax would be released for other uses.

CONSAD has used an economic forecasting model developed by Regional Economic Models, Inc. to estimate the effects of the resulting changes in those peoples consumption and investment spending on the aggregate economy. The estimates indicate that eliminating the tax would result in an initial surge in gross domestic product (GDP), the aggregate value added for all firms in all industries throughout the economy. Then, by the fourth year after the repeal, the benefits from reallocating resources toward investment, tempered by monetary policy aimed at averting inflationary pressure, would stabilize and yield steady growth in value added.

If the estate tax were phased out over five years, GDP would surge in 2002 to a level between $12.2 billion and $14.0 billion (in 2000 dollars) higher than it would be without the policy change. In 2004, GDP would moderate to a level between $4.0 billion and $7.0 billion higher than it otherwise would be. By 2010, the increase in value added would be between $3.2 billion and $8.1 billion. Cumulatively over the ten-year period, GDP would be increased by a total amount between $61.2 billion and $86.8 billion. It is also projected that the stimulative effects on the economy would be greater if the estate tax were phased out over three years or were immediately repealed than they would be with a five-year phase-out period.

The projected effects on individual industry sectors are similar for all phase-out scenarios. Many industries would experience notable increases in value added. These industries include machinery and computers, electronic equipment, motor vehicles, instruments, real estate, retail trade (excluding eating and drinking establishments), wholesale trade, and medical services. These industries employ almost 49 million people: more than one-third of the total private sector employment in the nation. All of the industries with projected increases in value added during each year account for more than two-thirds of total private sector employment. The aggregate gains in value added in those industries far exceed the decreases that would occur in the few industries that would experience decreases in demand for their services due directly or indirectly to repeal of the estate tax.

For more information about the research, contact the Food Marketing Institute at 202-220-0635.