Martin Regalia: Econ 101 The Case for Killing the "Death Tax"   View a chart on the Complexity of the Death Tax MEMBERS TAKE ACTION! JOIN the GAIN Online Action Center.

While many people believe that there is no such thing as a "good" tax, most would acknowledge that there are some necessary taxes. After all, tax revenue pays for a variety of public goods, including national defense, education, and infrastructure such as roads and bridges.

Nevertheless, when the government in a free society uses its power to tax, it has the obligation to do so in the least intrusive fashion. That is, the taxes imposed should meet certain basic criteria: simplicity, efficiency, neutrality, and fairness. A number of U.S. taxes fail to meet these criteria. The estate, gift, and generation-skipping tax—commonly known as the "death tax"—is a prime example.

The death tax is anything but simple. The death tax is a multipart taxing mechanism so complex it has spawned an entire industry of estate planners. Even in its simplest form, the death tax is Byzantine. It requires the computation of the "fair market value" of all the deceased’s assets—no mean feat if these assets are difficult to value, such as a family farm or a family-owned business.

After deductions are subtracted, the remaining taxable estate is subject to the application of up to 17 different tax rates. A 5% surcharge also applies to certain large estates, pushing the marginal rate of tax up to 60%. There are also generation-skipping provisions designed to tax transfers from grandparents to grandchildren at an effective rate of up to 80%. And if that were not enough, one must contend with a basic estate tax return form that totals 44 pages, not including instructions, which by IRS estimates takes close to a full work week to complete!

The death tax is inefficient. Taxes are efficient when they waste few resources in the collection process, impose no unnecessary compliance costs on taxpayers, and make a high percentage of the proceeds available to pay for public goods. With the death tax, collection and compliance costs are high because even individuals and businesses that do not incur a tax liability spend time and money on estate planning and return preparation.

For example, recent survey data revealed that the average family business spends nearly $20,000 in legal fees, $11,900 for accounting fees, and $11,200 for other advisors. Average spending for tax planning (e.g., attorney/consultant fees, life insurance premiums, internal labor costs) was nearly $125,000 per business. Wouldn’t these resources, not to mention a business owner’s time, be much better spent on expanding these businesses and creating jobs rather than avoiding taxes?

The death tax also distorts economic decision making by encouraging consumption at the expense of saving and investment. Economic theory suggests that the more a particular activity is taxed, the less of it one gets. The death tax represents a tax on entrepreneurship, risk taking, and the accumulation of saving. As such, it leads to less job creation and less economic growth. Small business owners and other individuals are encouraged to spend their accumulated saving prior to their death and to cut back on entrepreneurial activities—that is, work less. The death tax gives them no incentive to save more or to push their business to expand and create jobs. Further waste is reflected by the large percentage of firms that have restructured their businesses at great cost solely for death tax purposes.

The death tax’s cost to the economy has been sizable. According to the Congressional Joint Economic Committee, in this past century the death tax has reduced the stock of capital in the economy by $500 billion, a 3.2% reduction from what it otherwise would have been. Furthermore, the committee estimates that eliminating the death tax would increase the Gross Domestic Product almost $34 billion over the next seven years and create almost 250,000 new jobs.

The final characteristic of an acceptable tax is equity or fairness. The death tax is anything but fair. A democratic society ought to have a better reason for taxing a particular group than the fact that that group saved more, risked more, and worked harder when they were living.

Moreover, the assertion that death taxes harm only the rich is wrong. To the extent that these taxes reduce saving and investment, they slow economic growth and job creation. When a family-owned business has to curtail growth or, in many cases, liquidate part or all of the business to pay death taxes, it hurts everyone involved—owners, customers, suppliers, employees, and their families.

The death tax is an inefficient, distortive tax that discourages saving, investment, and job growth; unfairly penalizes small businesses; and raises relatively little money for the federal government. This last point is perhaps the crowning insult. The death tax carries all this negative baggage but only raises a miniscule 1.5% of total federal revenue. Furthermore, death tax avoidance strategies reduce income tax revenue, which may actually result in a net revenue loss for the federal government.

The death tax is both grievously flawed and unnecessary. It is high time that it be taken off the books and laid to rest.