Estate Tax’s Disappointing Legacy Invites Repeal

The federal estate tax, which in theory is supposed to prevent the buildup of inherited wealth and give society equality of opportunity, is not really accomplishing that purpose now, by all accounts. So it should be repealed--and probably will be in the next few years.

Estate tax repeal will be part of any tax relief package put forward by Congress this year, although no tax bill is likely to go far this session.

But the idea of eliminating the estate tax, which begins at 37% of inheritances over $650,000 at present, will be brought up in tax bills from now on. It is an idea whose time has almost come.

Reflecting bipartisan support in Congress, Sens. Jon Kyl, (R-Ariz.) and Bob Kerrey (D-Neb.) have proposed a bill to repeal the tax. Two bills in the House--one by Rep. Christopher Cox (R-Newport Beach)--propose repeal, and the idea has the backing of Rep. Bill Archer (R-Texas), chairman of the tax-writing Ways and Means Committee.

Small business supports repeal, since the burden of paying estate taxes can force the sale or breakup of a closely held family business. The National Assn. of Women Business Owners, which claims 9 million members, testified for it in Congress last week. “I worked hard to build Neese Personnel Services. I want to leave it to my daughter who just joined the firm,” says Terry Neese, the head of NAWBO and owner of an executive search and temporary personnel firm in Oklahoma City.

Behind growing support is the growth of wealth in America. The long bull market, which has added more than $6 trillion to America’s national wealth, has swelled the value of 401(k) and other investment accounts. House prices have appreciated in many parts of the country. The numbers and values of small businesses and self-employed occupations have multiplied.

Academic studies show 4.1 million Americans with more than $1 million in net worth--assets minus mortgages and other debts. But the figure is understated because it doesn’t capture the buildup of retirement accounts.

Therefore more Americans than ever have substantial material wealth to leave to their heirs. As a result, says one tax expert, “repeal has gone in a few short years from a right-wing curiosity to a real possibility that both parties take seriously.”

Repeal will have opponents, to be sure. The American Assn. of Retired Persons doesn’t think much of the idea, reckoning that if this tax is repealed, another will be put in its place. Charitable foundations as a group have yet to take a position, but since wealthy people establish foundations partly to avoid estate taxes, opposition to their elimination would be logical.

Most important, the estate tax is not a simple matter. Eliminating it could worsen a situation that already makes many Americans uneasy. “Abolishing the inheritance tax would further encourage maldistribution of income and wealth,” says the Rev. William Byron, professor of management at Georgetown University in Washington.

On the other hand, Byron adds, if the government taxes wealth, it has a responsibility to use the proceeds to benefit all members of society. Estate taxes, in short, should help equalize opportunity.

The current U.S. tax doesn’t do the job. Too little is collected, for one thing. Last year estate taxes totaled $24 billion, or 1.3% of federal tax receipts. The money came from 43,000 estates, says the Treasury Department, an average of $558,000 per estate.

Thus it appears to be a tax that largely falls on family-owned small businesses. But most businesses and wealthy families avoid paying the tax directly by purchasing life insurance. Life insurance proceeds are generally tax-free and provide the cash needed to pay estate taxes. This often saves family firms from being sold to pay the tax bill, which is due nine months after an owner’s death.

The tax is flawed on several grounds, says Edward McCaffery, professor of law at USC and an expert on estate taxes.

“It falls on people who save,” McCaffery points out, “amounting to an incentive to spend now because the government is going to take half your money.” The estate tax tops out at 55% of any estate over $3 million at present.

And even though it is levied on heirs, the estate tax can amount to double taxation, taking a portion of income or profits at death that were taxed originally when earned during life.

Sens. Kyl and Kerrey’s proposed repeal bill would remedy those flaws by taxing inherited assets like any other assets, at capital gains rates of 20% when the heirs sold them.

But the chief flaw in the estate tax is that it hasn’t accomplished anything. The richest 20% of U.S. households control more than 75% of household assets today, just as they did a decade ago. Income disparities appear to have widened in recent years but for complex reasons having nothing to do with inheritance: a rise in single-parent families, displacements of occupations due to technological change.

Technology has both created wealth and reduced wages for certain tasks. So society faces a need to adjust to a new economy and new social forms. Reliance on the old form of estate taxes won’t do the job, if they ever did. The Romans imposed a 10% tax on property at death, yet originated patrician and plebeian classes; Britain taxed landed gentry yet remained an avowed class society. Classless America first imposed estate taxes in 1916 to help pay for World War I.

Eras have changed. Today’s pathways to opportunity and wealth lie in education and access to capital. How can we spread those around? By “increasing economic growth beyond what we have already,” says former U.S. Sen. Bill Bradley, who is running for president. Bradley would increase earned income tax credits for the poor and raise minimum wages to “lift the bottom 30% of income earners.”

The wherewithal for such reforms could be available. Surpluses in the federal budget will rise in the next decade, thanks in part to a flow of capital gains taxes on the wealth buildup seen in this decade. That will give government more leeway to expand benefits while the private economy expands opportunity.

That at least is the optimistic scenario. Repeal of the estate tax, by taking some pressure off small business, could help spur economic growth and opportunity. Which is more, in any case, than the tax is doing today.

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James Flanigan can be reached at jim.flanigan@latimes.com.