Liberty, Equality...and the Death Tax

Any serious debate about the future of estate taxes must touch on entrepreneurial initiative, trusts, and our convoluted revenue code

By Christopher Farrell

The casualty list from the stock market funk is long and growing. The bear market has transformed CEOs from celebrities forging the New Economy to malefactors of wealth. The popular idea of early retirement funded by a windfall of double-digit stock market gains has gone the way of the 35-hour workweek. The political movement to privatize Social Security has collapsed as stock values have cascaded lower for nearly three years. The fashionable notion that federal surpluses stretched as far as the eye could see proved false as the budget deficit blows through $150 billion.

The death of the idea to repeal the estate tax could be next. President Bush ran on a platform to eliminate the so-called "death tax." But he hasn't done it yet. The estate tax provision in his 2001 tax bill ranks among the most bizarre features of the U.S. tax code -- and there's plenty of competition. The estate tax rate gradually declines to zero by the beginning of 2010 only to be reinstated at the end of that year at the old 55% rate. (Put somewhat differently, while this column was being written, there was 3,067-odd days, 46 minutes and 5 seconds remaining until the tax kicks in, according to the No Death Tax clock.)


  The Senate came close to a vote to permanently repeal the estate tax as recently as June. But the current economic and social climate is no longer hospitable for eliminating taxes on transfers of vast wealth, not when the bear market has exposed ethical bankruptcy in executive suites, widespread corporate chicanery, and infectious greed among the pin-striped elite. This doesn't mean that the estate tax debate is over.

Just about every supporter and opponent of the tax agrees the current law is an abomination. Lawmakers will be forced to revisit it. Short of repeal, America should reform how it treats bequests. The aging of the population, along with the rise of household wealth in an increasingly entrepreneurial and innovative society, argues for keeping the estate tax exemption high, perhaps at the $3.5 million level slated for 2009. Better yet, estate-tax reform should be part of a broader movement to bring down all tax rates in return for eliminating many tax shelters, especially in the evasive, intricate world of trusts.

Of course, rewriting the estate tax laws won't be easy since it will involve confronting classic trade-offs between equity and efficiency. For example, the estate tax modestly reduces wealth accumulation and does induce tax avoidance and evasion, according to a recent study by economists Wojciech Kopczuk of the University of British Columbia and Joel Slemrod of the University of Michigan. Yet the scholars add that the tax is the most progressive federal levy on the books, encourages charitable giving, and leans against concentrated wealth.


  The tax also gives concrete expression to the popular belief that equality of opportunity is an American ideal, the notion that money and power should spring from one's own brains, savvy, and pluck rather than being born into affluence, says J. Bradford DeLong, economist at the University of California, Berkeley, in a thoughtful essay, Bequests: A Historical Perspective.

(DeLong's paper was given at a Boston College Center for Retirement Research conference on the "The Role and Impact of Gifts and Estates." The study Tax Impacts on Wealth Accumulation and Transfers of the Rich, by Wojciech Kopczuk and Joel Slemrod was presented at the same conference.)

In its current form, the estate tax hasn't stopped families from holding on to vast sums of money. The tax has only been applied at most to the richest 6% of Americans over its history, and, in recent years, it has been imposed on fewer than 2% of Americans who die. A sophisticated network of high-priced professional talent keeps the tax bite at a minimum.

For instance, the Rockefeller clan remains immensely wealthy. The New York-based aristocracy chronicled in the novels of Louis Auchincloss may no longer wield great power, but a dense network of inherited wealth still trade deals on Park Avenue, send their "legacy" children to Ivy League colleges, and summer in Bar Harbour.


  Nevertheless, despite the nation's divisions along the lines of money and power, America has been more egalitarian and open to talent for much of its history than almost any other society. The modern estate tax, which began with the Revenue Act of 1916, is a vital part of that social democratic history.

Indeed, American society brought about a revolutionary change in bequests. In most societies, including the Anglo-Saxon world, inheritance was designed to maximize the wealth and power of the family. That's why in England, a land-short and slow-growing economy, the eldest male got the bulk of inheritance while the other heirs suffered financially.

The migration to America broke the pattern of primogeniture, according to DeLong. In the 18th century, a rapidly expanding economy with a wide-open frontier and a fluid social structure encouraged an equal division of assets (at least among the males). The frontier also leveled the playing field between hardscrabble entrepreneurs out to make their fortune and lucky sons maneuvering for their fathers' money.

Then the country's 19th century industrial elite staked their huge claim on the nation's wealth with vision and daring. Gilded Age plutocrats were a force for corporate innovation and economic growth. But their children couldn't make the same claim. That's why the tycoon Andrew Carnegie called the estate tax the "wisest" tax.


  "The Lockeian argument that John D. Rockefeller had earned his fortune by the sweat of his brow and his acts of Schumperterian entrepreneurial vision (plus the distribution of well-placed sums to the members of the Pennsylvania legislature) did not apply to the fortune of his children," says DeLong. "Hence the coming of social democracy to America was accompanied by high statutory tax rates on large bequests."

The attempt to abolish the estate tax could be looked at as a desperate effort by a beleaguered aristocracy to hold on to increasingly tenuous positions of privilege for their children. The past 25 years represent a pivotal moment in U.S. economic history. The technological and organizational innovations that have come to cumulatively define the new economy, from information technologies to the flexible workforce, are opening unheard of opportunities for entrepreneurs.

When the New Economy emerges from the downturn -- and the New Economy will survive even as many high-tech companies fail -- the economic rewards will spread surprisingly fast throughout much of society. The estate tax should be reformed to reflect that coming renewal of a rise in equality of opportunity.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online

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