January 12 2010

Don't Fear the Reaper - Fear Uncle Sam

Nicole Kurokawa Neily

The federal government managed to get something right on January 1 (entirely unrelated to the fact that they were closed!). For one year, the "death tax" has been repealed. That means that assets transferred after a person's death, such as homes, cars, furniture, and retirement accounts, will not be subject to a government levy. Paid by heirs of the deceased, the tax adds insult to injury (you mean I have to pay the government for this horrible collection of Hummel figurines I inherited?) at a time when loved ones should be grieving, not filling out paperwork.

Although its proponents couch their arguments in terms of class warfare, in reality the death tax hurts average families, not the very wealthy. The mega-rich have armies of accountants and lawyers to help shelter funds from such taxes - but more average families, who are likely to bear the brunt of this policy, do not enjoy the services of such personnel.

The death tax runs counter to one fundamental underpinnings of American society. Part of the American dream is for parents to be able to give their children lives that are better than what they had. People work hard to provide for their families, and often strive to better their children's economic situation by leaving an inheritance after their passing. Unsurprisingly, Uncle Sam wants in on the action, despite not being in the will.

The death tax is fundamentally unfair: it punishes those who saved money with a new round of taxation while money that was fully consumed escapes this new government levy. The estate tax is one of the best examples of government double-dipping by taxing money that has already been taxed before. The worker who earned the money has already paid income and/or business taxes. And let's not forget those lovely things you bought for your home and office with your after-tax dollars - the government also collected sales tax on them, too. But hey, who's keeping score?

Family businesses are particularly hard hit by this tax: a 2006 report by the Joint Economic Commission notes that between 1995 and 2004, estate taxes were paid by the owners of more than 37,000 "closely-held businesses,'' as well as 24,000 farms, 50,000 limited partnerships, and nearly 28,000 other non-corporate businesses. Businesses that know that they face such penalties are discouraged from capital investments - why bother to buy a building, or equipment, when the government will take half its value eventually?

For those enterprises that are cash poor but asset rich, such as farms, selling the family business to pay the tax bill may be the only option available. When those family businesses close, the jobs they provided often disappear.

Yet the costs of the estate tax don't just kick in at the owner's death. Recognizing the potentially devastating effects of the death tax, small businesses seek out insurance policies and special long-term planning advice. Money that would have been used to hire workers and expand production is thus spent on lawyers and paperwork. This unseen barrier to entrepreneurship slows economic growth, further hurting future generations.

According to the American Family Business Institute, the estate tax has reduced overall capital in the economy by $847 billion over a ten-year period, while annual compliance costs with the tax - approximately $18 billion - are approximately the same as the amount as the revenue it brings in. In other word, the death tax is among the government's least efficient revenue raisers: it raises relatively little ($18 billion is hardly a blip in the modern federal government's overblown budget) but imposes major compliance costs, creating what economists call dead weight loss for the economy. It's simply bad policy, based on just about any measure.

Unfortunately, the battle to kill the death tax is far from over. Without further action, the tax comes back with a vengeance in 2011 at a 55 percent rate for assets over $1 million. The House passed its fix in December, with a 45% rate and a personal exemption of $3.5 million, while the Senate has yet to address the issue. The Senate version is expected to impose a 35 percent rate and a $5 million personal exemption - an improvement, but still one of the highest rates in the world. A 2007 study by the American Center for Capital Formation reveals that the average rate for countries that have an estate tax is 24 percent, while major nations such as China, Russia, and Mexico do not have one at all. Does moving from a very high rate to a slightly lower, but still-high rate enhance America's competitiveness in a global marketplace? Hardly.

Current rumblings in Congress indicate that lawmakers hope to pass legislation making this increase retroactive, so that those people who think they got off for cheap in 2010 will receive a nasty bill in the mail. President Obama's budget forecasts rely on the reinstatement of the death tax (as well as the repeal of the 2001 Bush tax cuts), showing that not only does the government want your money, but it feels unquestionably entitled to it.

America became great because of its values - hard work, thrift, and family. Unfortunately, the death tax penalizes these values, instead encouraging consumption and laziness. If the time and money spent complying with (or trying to avoid) the death tax were instead used for hiring and expanding, small businesses and families-and indeed the entire economy - would be much better off. It's time to keep much-needed capital where it belongs - in the economy, and out of government coffers. For the good of the nation, it's time to retire the death tax permanently.

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