Thursday, April 14, 2005

Best Estate Tax Post Ever

by Tom Bozzo

Kash at Angry Bear reduces the estate tax repeal down to its foul essence: big tax increases for (living) people with decent incomes but not taxably large wealth — i.e., essentially the entirety of the middle and upper-middle classes. Why the anti-repeal debate wasn't originally framed as tax increases for you and me so that the country's Paris Hiltons can live tax-free is beyond me.

What the easy passage (in the House, at least) of a Bush policy so bad that it even loses the Wisconsin State Journal's editorial page means for the prospect of fiscal sanity under the Republicans is left for an exercise.

Some of the tax increases will evidently come from non-reform of the Alternative Minimum Tax. Citing a New York Times article, Mark Thoma notes that AMT "reform" will at best bring about a new and improved AMT. From interviews with commissioners, Bush's tax "reform" commission has too narrow of a remit to recommend major net changes (a not uncommon feature of these Bush-era commissions, BTW). That is, AMT reform has to:
  1. Be revenue neutral (against a baseline that includes exploding AMT payments), and
  2. Assume the current income tax rates are made permanent.
Not many degrees of freedom there!

I'll go out on a little bit of a limb and say that this is not necessarily the worst thing. Obviously, a return to those growth-killing tax rates of the late '90s would be simpler and arguably fairer. However, if non-policy political concerns take that option off the table, then an improved AMT does the trick of raising desperately needed revenue from people who by and large can afford to provide it.

I'd emphasize that the biggest problem with AMT is not the mere idea of putting a floor on income taxes for higher-income taxpayers, so much as its bizarre rules for forms of income most people probably didn't know existed. In the light of Nina Camic's tax travails, I'd suggest as another exercise reading the instructions for IRS form 6521 with a stopwatch at hand. Time how long it takes you to either black out or reach for a very large and stiff drink. Take out the crazy income and deduction rules and AMT is just a flat-ish tax, which some conservatives are supposed to love.

That all makes the heroic assumption that the "reform" won't be massively screwed up.
I will look into your comments about the estate tax more thoroughly, but it seems farcical to me to think of a tax cut as a tax increase. The death tax affects a lot of middle class people, especially those with lots of non-cash assets. Always dreamed of living in the house where you grew up? Too bad, because the government just took 55% of it. Hope you enjoy your half-bath...

But, also on a fundamental level, the estate tax is wrong for two main reasons, IMHO. First, it is a tax on money that has already been taxed - and that should be a no-no. Second, it is a tax that essentially is a redistribution of wealth, which I think the government should also avoid if it is possible. Obviously we need some redistribution of wealth, such as government programs to help the poor, but there is no clear reason to me why a tax whose sole purpose is redistribution of wealth is a good idea.

If you are worried about fiscal sanity, then I say increase the income tax a proportionate amount to what the death tax would lose ($290 billion over 10 years; although note that the death tax is gone by 2010 anyway and the current talk is just creating an extension for the repeal of the tax).

BTW, one final thought. FDR is the father of the mega-estate tax - he raised the estate tax to 60-70% and increased the top income tax rate to 75%. Just because he passed them, doesn't mean we need to keep them.
Bryan, a few points in reply:

1. A tax cut that isn't matched by spending cuts really isn't a tax cut, but an intergenerational tax shift -- Ava, John, and Julia (plus us when we're older) get to pay more income tax to service the additional debt.

2. A hypothetical revenue-neutral repeal of the estate tax would shift the tax burden such that relatively few (taxable estates) get a huge cut, while relatively many income tax payers would see increases. Remember, the rejected Democratic alternative would have raised the exclusion for a couple to $7 million. Very few people leave estates of that size (for that matter, few even leave estates larger than the pre-Bush exclusions), so for most income tax payers, this would be a pure increase.

3. If you look at household wealth data, it just can't be that "a lot" of middle class people face estate tax bills. The suggested increases in the minimum size of a taxable estate (see #2) would largely eliminate any remaining issues for people in areas with expensive real estate. Plus, it's ridiculously easy to obtain cash from one's real estate equity, making it more unlikely that houses would need to be sold to cover estate tax bills.

4. It's not necessarily true that the assets in an estate were previously taxed as income -- consider a bequest of the proceeds of a tax-deferred acount like a 401(k) or traditional IRA.

5. I am worried about fiscal sanity because the potential consequences of unsustainable policies are worse than paying a bit more tax now. I'd not object to an income tax offset of the estate tax revenue (provided it was pitched at the upper brackets, and treated wage and capital income to be treated more equally than is the current policy direction), particularly as the Clinton-era tax rates we'd be talking about wouldn't be anywhere near the very high rates you mention in your comment. I'd note, of course, that income tax increases are off the table, as a political matter, from your side of the aisle.

6. The big FDR-era tax rate increases were largely to help pay for WWII. My counterpoint is that the postwar boom occurred under tax rates we'd both consider confiscatory. But those rates are gone and don't need to come back, so I think they're somewhat beside the point.
Uh, what "growth-killing tax rates of the late '90s"?

Dow (Jan 1996 close): 5,395.30
Dow (Dec 2000 close): 10,787.99
Dow (current): 10,334.62

It appears all the growth-killing was done in 2001 and forward.
Ken: "growth-killing tax rates of the late '90s" was a joke. (Whenever Greenspan says something to the effect of how terrible it would be to raise taxes back to Clinton-era levels, I would like him to show me the dollar that went unmade in the time period you mention.)

Even not cutting spending does not make it a tax raise on future generations. If the economy really booms, the government will get more revenue from the same income tax rates they have now. I hope my thinking isn't too simplistic there.

Second, I think fiscal sanity arguments need to be reserved for the income tax. As I said before (with your correction noted), the estate tax is mostly taxing already taxed income. In addition, it's a tax that's sole purpose is a redistribution of wealth, which is not the American way... Just because we have a huge budget deficit in DC (to use an extreme example), doesn't mean we should send out the National Guard to beat up people and steal their wallets. Some forms of taxation are acceptable, others are not. IMO, the estate tax is an unacceptable form of taxation. Personally, I'd be okay with increased income taxes right now and I'm a Republican - so I'll fight from the inside.

BTW, on a whole other point, what is your opinion on deficits as a percentage of GDP? Many economists don't see the deficits as a problem since they are such a tiny percentage of GDP. I have always had trouble understanding this argument.
Tom - My irony-detector was clearly impaired. Or I was channeling Martin Feldstein.

bryan - Reasons for taxes are often stated. The reason for this one (which, in full disclosure, my family has paid willingly) still stands as accurate as summarized here.
Tom, one more thing. 20% of the Democrats in the House voted to repeal the Estate Tax. That's pretty good bipartisan support. I imagine if the deficits weren't so large right now, that number would be even higher. The Estate Tax repeal isn't just a Republican goal.
Ken, thanks for the link. I'm also going to steal the link you provided in the MaxSpeak comments. (A good Adam Smith quote is provided there, too.)

Bryan: The tax shift argument is simple. If estate taxes are cut by $X but spending is the same, then the spending is financed by issuing (additional) bonds in the amount of $X. Since the bonds are "merely" claims on future tax revenues, future income tax payers pay $X with interest.

Maybe the burden of paying back the $X plus interest will be lower in the future, maybe not. Whatever, the burden has been transferred from a smaller and richer segment of the population to a larger and (relatively) poorer segment. In considering the "American way," you should note that the change from the status quo is a reverse Robin Hood redistribution of wealth.

As for the estate tax repealing Dems, I expect it's a (largely mistaken IMHO) political rather than policy calculation they're making.

The simpler example: If you run a store and I steal $100 from it, does that mean I've done nothing wrong if you make $200 more than you expect to the next week?
Ken, So we're going to run the government like a business now? Count me in...
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