Government Affairs

No Taxation Without Respiration

Is there too much taxation in America? Republicans want to cut taxes, Democrats want to stay the course. But whatever one thinks of the total tax burden, there can be little doubt that there are too many taxes— Americans seem hit with a variety of taxes, from cradle to grave, on just about every aspect of their lives.

Given that, suppose I told you that I could devise a tax that would be wildly unpopular, excessively complicated, and unarguably unfair. It would collect whatever money it could from people's estates, nine months after their death. But the tax wouldn't net much money under the best of circumstances, and might even lose money. It would almost certainly cost the society large amounts of capital over time. Appealing, huh?

Well this tax is already on the books and it's called the estate tax.

Fortunately, some in Congress want to put an end to this tax. Reps. Jennifer Dunn, R-Wash., and John Tanner, D-Tenn., for example, have co-sponsored legislation to phase out the gift and estate or the so-called "death tax." The Dunn-Tanner bill lowers rates by 5 percentage points each year, leading to a total abolition of the tax by the year 2010. Ending the death tax should be a non-partisan issue that Republicans and Democrats can support. The death tax is a bad tax under just about any light.

The tax applies only to the few who die with significant assets. It isn't, therefore, all that surprising that the wealthy who live in the shadows of the death tax go to some lengths to avoid its sting: who wants to contemplate the specter of Uncle Sam dancing on one's grave as one lays dying? The resulting planning techniques lead to a tax that is among the most costly and complicated in the entire panoply of federal taxes.

Yet, the death tax raises little money— about 1 percent of federal revenues, in gross. The net situation is far worse. This is partly because the tax is costly for the government to administer and enforce. Even worse, as the economist Douglas Bernheim pointed out some years ago, the death tax encourages wealthy patrons to engage in transactions— like setting up bizarre forms of irrevocable insurance trusts— that cost the government income tax revenue. In the best of all worlds, the tax probably does little better than break even.

It can get worse, and it does. The incentives of the death tax are simple enough to state, and they fall heavily on America's wealthiest citizens and its most productive savers: Don't work. Don't save. Spend what you have, now, because you can't take it with you. If you insist on caring about your own posterity, give early, often, and in trust. But these behaviors all have bad long—term consequences for the country.

A recent study by the Joint Economic Committee of Congress trumpets some striking statistics about the death tax. Among the principal findings:

—The existence of the death tax has reduced America's common pool of capital by nearly half a trillion dollars;

—The tax leads to less savings and investment and a distorted allocation of resources;

—The tax is a leading cause of the dissolution of thousands of small, family-operated businesses, and planning for the tax diverts billions of dollars from the potentially productive activities of these companies;

—The compliance costs of the tax are roughly equivalent to the tax's gross yield, or about $23 billion in 1998;

—The tax has little or no net effect on charitable giving at death.

The true costs

The death tax has been in place since 1916. It has never raised much money, in absolute or relative terms. Economists plausibly argue that the tax might even lose money, on balance. There is also the real possibility of decreased work and savings by our wealthiest citizens.

But money isn't everything. After all, the best arguments for the death tax have never been narrowly economic. Proponents rest their case on moral grounds, arguing that the death tax is fair because it falls on the most fortunate few, increases the overall progressivity of the tax system, breaks up large concentrations of wealth, and attempts to level the playing field so that the sons and daughters of the rich won't have undue advantages in this world.

That's all perfectly noble. But the problem with the moral case for the death tax is that it is wrong, as both a factual and a moral matter. Inequalities have gotten worse, not better, in the face of the tax. But the death tax isn't just ineffective. It's also unfair. The best arguments against the death tax turn out to be moral ones, too, and the balance of the fairness arguments suggest repeal of the whole mess. For the death tax falls on thrifty savers, and spares altogether luxurious spenders; it rewards avarice and selfish consumption, and penalizes frugality and intergenerational altruism. What's fair about that?

What of those arguments about breaking up large concentrations of wealth and making heirs pay something for their good fortune? It turns out that present law, despite its good intentions, makes these problems worse. Under today's tax system, wealthy people who are well advised and plan ahead can get millions of dollars to their descendants, tax-free. The kids pay nothing on the receipt of the money. Nor do they pay any federal tax at all— no income, no social security, no nothing— when they spend away, even if they burn through the family fortune in a few years or so. That's pretty crazy.

The people seem to have figured this out on some level. Polls consistently show that Americans do not like death taxes. Meanwhile, there is much support for the idea of a general consumption tax— a national sales tax, say, or even something that looks like the current income tax but with a better, more systematic exemption for savings.

The concerns about heirs and the concentration of wealth can and should be met without a death tax. Imagine, for example, that we had unlimited tax-free savings accounts, like IRAs under current law. No tax would be due on money earned and saved until and unless it is withdrawn and spent.

A wealthy person could give all or part of her account to anyone, at any time, on life or death, without triggering a tax on the transfer itself. When and as the heir withdrew the money, he would be taxed. If the heir got greedy and tried to pull all of the money out too quickly, to spend on foolish whims, the burden of progressive rates would fall on him.

In contrast, special exemptions for medical, educational or charitable spending might encourage these uses. Wealthy patrons, who have demonstrated thrift throughout their lifetimes, should like this plan for monitoring their children's spending habits. On a social level, the plan focuses the act of taxation consistently on private consumption, not on the socially useful activities of work or savings.

Americans like "sin" taxes, as on alcohol and cigarettes. The death tax is a virtue tax. It is a tax on industry and thrift, on intergenerational altruism, on work and savings without consumption. It's unfair, plain and simple, and should be killed, once and for all.

Edward J. McCaffery is Professor of Law at USC Law School and the California Institute of Technology. He is the author of "Taxing Women" (1997) and the forthcoming book, "The Next Great American Tax Revolt."