Estate Tax or Death Tax?

We've discussed before my hatred for all things tax-related, but let me clarify a bit. It's not so much that I dislike paying taxes. In fact, I'd be totally fine paying taxes if one thing would occur -- the government would spend those taxes wisely without wasting a good percentage of them. Paying taxes is like pouring water down a drain. Yeah, some good happens (the drain gets cleaned and is kept functioning), but so much is wasted. If I had a kid like the government, a child who wasted as much as they do, I'd cut him off. Why give money to someone who's going to blow a ton of it on nothing? But I digress.

Today I'd like to highlight one of my least favorite taxes, the estate tax (that's what people who like it call the tax, most others call it the "death tax.") Anyway, CNN has a piece on how Warren Buffet is in favor of the estate tax. This is a fairly easy position for him to take since 1) he probably has several ways to shelter much of his assets from estate taxes and 2) 50% of ninety ba-zillion dollars still leaves his heirs as ba-zillionaires.

Buffet gives several of his thoughts on estate taxes as follows:

Buffett said he would raise the amount of estate assets exempt from the estate tax from the current level of $2 million to $4 million and end up with a top rate higher than 45 percent.

But, he said, he'd put in a more gradual slope in rates in terms of how heavily assets above that $4 million are taxed. He also indicated he might include an exemption for small family-owned businesses so that they wouldn't be forced to sell off assets to meet their estate tax bill.

Buffett also said it was important that estate-tax laws be clear and consistent rather than having exemption levels and rates change each year. "I wouldn't have the capriciousness of the 1-year this and 1-year that. ... I don't think people should have to guess when they're going to die."

Ok, I'm fairly "ok" with these thoughts, though personally I don't like the death tax. Why? My main issue is that it's double taxation. The government has already taxed the assets (or at least most of them) that are passed on -- why tax them again? I know -- the first tax was on the owner and the second was on the recipient. That's a clever argument, though the point remains the assets themselves are double-taxed.

The piece also includes this little bit:

Committee Chairman Max Baucus (D-Iowa) noted that the committee would be dealing with the issue of tax reform "aggressively" next year and asked Buffett for his views on how the tax code should be reformed.

Buffett noted that he thought the code should be more progressive - meaning those who make more should pay even more than they do now relative to those who make less. "We ought to do more for [low-income Americans] and take more out of the hides of people like me."

Oh yeah, that's a GREAT idea. Let's give even MORE to the government to waste. Let's give even less incentive for people to work hard, get ahead, employ more people and the like. After all, once high earners see that so much of their extra income is going to taxes, what's to keep them motivated to work more? Not much.

Yeah, I guess I'm getting more cynical as I get older. The topic of taxes does that to me -- especially the estate tax.

The reason I started this post was to ask you all what you think of the estate tax. Is it fair? Should it be repealed or maybe increased?

Comments

[Kevin]

I can see the arguments both for and against the estate tax and personally I really don't care either way. I kind of like the idea of redistributing wealth from the uber-wealthy when there are so many people scratching and clawing to get ahead in this country, so I guess I'm for it. After all, is there really that much of a difference between a billion dollars and 2 billion? I do wish the government would spend a little more wisely, but it's clear even the Republicans (who are supposed to be more conservative) can't control themselves, so it's probably a lost cause.

Good planning goes a long way with the estate tax. And it really doesn't cost that much to hire a good lawyer and get it done. I just did an estate tax return for a guy that had over $5 million in assets and paid -0- estate tax.

As far as small businesses go, there are already provisions in place to protect both business and farm interests. And for those cases the estate tax can be paid in annual installments rather than one lump sum. Most people in this position have life insurance to help pay the tax bill.

[Evan]

I deal with the Estate tax on a daily basis (literally).

The federal estate tax is a hot button with most people - because of the sheer audacity of it - "The federal government is taxing me after I am dead!" However, depending on whose stats you want to pay attention to - it only hits somewhere between 1 - 6% of the ENTIRE COUNTRY (2% is the number the IRS uses)

This blog is read by intellegent people who are hopefully saving! But in reality how many of your readers are in that 2% elite status? I suspect that it has to do where your readers live, since their home will be their #1 asset. For instance - New York (where I live) and Cali - are up there in providing Estate Tax.

Another little interesting tidbit - the quintiles that pay the most estate tax are the First and Third, NOT the first and Second! My theory - First can't avoid it, and Third refuse to do anything about it.

Notwithstanding the foregoing, I am against the Estate Tax, but not for the audacity of it, but rather your reasoning of double taxation. The "receipent" counterargument does not hold water - because you can give your entire estate to your spouse and HAVE NO TAX! That means I can pass $50,000,000 to my spouse and literally have NO TAX. Similarly, I can provide $50,000,000 to a charity and AGAIN have no tax!

Sorry to be long winded to come to the same conclusion as the blogger, but I feel that most people misunderstand the estate tax and put forth emotions when 98% people don't have to!

Side Note - in 18 States (a/k/a Decoupled States) there is a State Estate Tax where the exemption amount (the $2mil this year, 3.5 in 2009 and 1mil in 2011) is LOWER. So in New York if a person dies with exactly $2mil - they will owe ZERO to the Federal Gov't but owe $99,600 to New York State.

[Jeff]

You mentioned that Buffet will leave his heirs. However, I have previously read that he will not be leaving any money to his heirs. He wants them to make their own money and not be spoiled by his money.

[ChrisV]

Evan makes the good point that this tax only effects a very small number of us. If Buffett gets his way, it will be still a very small number.

So why all the fuss? Is it because the people who want to abolish the tax have done an excellent job of fear-mongering? I think so. They have "marketed" their cause as a rally against high taxation (even the blogger has bought into this) and they have cleverly renamed the estate tax to a "death tax". It's the few rich who are effected by this that are trying to convince the rest of us that the big, bad government is after our wallets again.

[FMF]

Evan (and others) --

A net worth of $1 million and life insurance proceeds of $1 million put you at the limit. Not a lot of people are there, but it's not a small number either -- and $2 million isn't a ton of money if a surviving spouse needs to live on it for a few decades.

Jeff --

In this case, I used "heirs" in the larger sense. If replacing it with "estate" makes it clearer, you can do so.

That said, I believe Buffett has said he'll live some to his heirs, but not enough to make them vastly rich.

[Evan]

@FMF,

Despite, your analysis of what is or isn't a lot that (i.e. 1mil + 1mil) I have given you the % of people. So regardless of whether you consider dying with $1mil life insurance and $1mil in other assets a lot or not alot - it is the same 2% of people affected.
Additionally, and somewhat related (maybe)if most people have term insurance - term only pays out approximately 2 - 5% (again, depends on the stats you want to listen to) then to have $1 mil at death is unlikely.

Also - most people with $1mil in Life Insurance will place the insurance in an ILIT (Irrevocable Life Insurance Trust) anyone that doesn't, deserves to get taxed. If your attorney or insurnace salesman stears you away from ILIT and you have a near taxable estate - FIRE THEM.

[Kevin]

Evan is correct in that you can leave $50 Mil to your wife, but when she dies, that is all in her taxable estate...unless there is planning involved.

FMF - similarly, in your $1 Mil of life ins and $1 Mil of "other", that can all be passed to the spouse tax-free. This fact is frequently left out in mainstream articles that tout it as the "death tax". That $2 mil invested in a money market account could make $100k a year without even touching the principal.

[Jamie]

Several people have commented that the estate tax only affects a very small percentage of people and this argument is shared by most Americans, otherwise our tiered tax system would not be tolerated. It's a convenient argument because it's easy to say that at least 94% of the population doesn't have to worry about it. But few people seem to be looking at the principles at stake. This is a Robin Hood mentality of take from the rich to benefit everyone else. Sure, an incredibly wealthy individual can live well with half of his or her income taken and given away, but is it fair to demand that the most successful among us give up one dollar for every two that they make?

We need a tax system that applies evenly across the board. The Fair Tax is a very reasonable example because it means everyone pays, it is virtually impossible to cheat, and it's a complete no-brainer. No one would need to spend additional money to try to figure out what they owe because there's nothing to figure out; the tax has been calculated and paid in minuscule increments throughout the year. There would be virtually zero need for the IRS, which would free up billions of dollars on a bloated federal bureaucracy. Imagine how much money could be saved by simply making the tax system more efficient.

[Rick]

I generally am FOR the estate tax, because it encourages money to move, rather than remain stagnant in one family from generation to generation. It encourages people to actually WORK for their money. We all see people like Paris Hilton who haven't worked but just inherited vast sums of money and then just waste and spend it frivolously. Having a high estate tax encourages hard work, rather than discourages it as FMF suggested.

And FMF said, "Let's give even MORE to the government to waste." This is a completely bogus argument in context, because the context is talking about a progressive tax structure versus a flat tax structure. Either way CAN be revenue neutral -- that is, this particular debate is not about the total revenue the government takes in, but who are the major contributors of this revenue. Is it spread equally among all Americans, or weighted heavily towards the more affluent.

Don't get me wrong, I am against taxes as much as anyone. And I would encourage you people to vote for the presidential candidate who wants to vastly limit government and eliminate all income taxes. But I would be careful of blowing off advise from Warren Buffet, one of the most successful financial wizards ever. The fact is, our current tax structure is actually largely regressive, which is the point that Buffet was trying to make.

[Rick]

Of course I know how to spell. "Advise" should be "Advice".

[JP]

"Estate tax or Death Tax"

Yes FMF, you do digress. This blog is getting the flavor of a Fox news special. Yikes - do you understand how your first paragraph smacks of greed. (Which I believe is a deadly sin.)

I have contributed to this blog many times under a few names, but I am outta here folks, I want to focus on finance, not faux conservative family values. Good luck and Happy Turkey to all

[Mark]

Evan,

What do you mean when you say "term only pays 2-5%"? Are you saying that 2-5% of Americans have term insurance?

[FMF]

Kevin --

I realize that you pay tax on the amount above $2 million. In my example, I was just showing that it's not that hard to reach the point where you'll start to pay tax.

Jamie --

I'm with you.

Rick --

1. Yes, Paris Hilton is wasting her money (or at least most people would probably think so), but still it's HER money (earned by her family) to spend however she wants.

2. I'd agree that Warren Buffet is one of the most successful INVESTMENT wizards ever. His prowess with setting and managing public taxation programs has yet to be determined. As far as I know, he's never drafted or enforced any tax law.

JP --

You disagree that the government wastes taxes? And this is greedy for me to think so? Didn't I say, "I'd be totally fine paying taxes if one thing would occur -- the government would spend those taxes wisely without wasting a good percentage of them."

First of all, taxes are a key part of personal finances. Look at your annual expenses at the end of the year and you'll see what I mean.

Second, if you think the government isn't wasting money, then, yes, you'll hate this blog.

Third, I made no comment on either political party (for all I can tell, it looks like they both waste money equally.) And yet you're upset. I guess it is best for you to move on.

[Adam]

Taxes (of any kind) is at the heart of any intellegent financial discussion JP.

Glad to hear you won't be back.

[Hawkmoon Nine]

Screw Warren Buffet. He's avoiding paying the Death Tax by planning of giving the bulk of his estate to the Gates Foundation. So taxes for Thee, but not for ME! If the Death Tax is such a great and necessary thing, why not give half to the government and the other half to the Gates Foundation?

I can't recall where I read it, but supposedly the Death Tax costs just about the amount to collect that it brings in. Meaning if we did away with it, the government wouldn't be out any money - but why do that when you can tell the masses that you're sticking it to the rich!

[Evan]

@Mark,

You misunderstood me - I am saying, out of the 100% of people who CURRENTLY HAVE term insurance, only 2 to 5 actually see any of that money. It is not because of some big bad insurnace company, but rather people lapse their poslicy, or die after the term is over. Its a bet that approximately 95% of the people lose.

I apologize, I can not find the study I am referring to, but if you google this subject, the number often used in the industry is 2-5%.

@JP,
I don't understand how this subject isn't a discussion of finance?

[FMF]

Hawkmoon Nine --

Any idea where you read that? I'd like to see the article as well -- and maybe post on it.

[Evan]

@FMF and Hawkmoon Nine,

I seriously doubt that stat - In 2006 the US Gov't collected OVER $24 Billion!

http://www.irs.gov/pub/irs-soi/06es02st.xls

[FMF]

Evan --

Oh well, it was good while it lasted -- all 11 minutes. ;-)

[Kevin]

Hawkmoon - how is giving money to a charity upon death worse than paying taxes? I would rather see the money put to good use by the Gates Foundation than squandered by politicians. Anyone can give money away to charity upon their death and that money wouldn't be subject to estate tax, it's one of the easiest planning tools out there.

FMF - I think you misunderstood my comment about the $1 M of life insurance + $1 M of "other". Yes, anything over that would be subject to estate tax, but there is an unlimited marital deduction, so the entirety of the estate would pass to the wife tax-free, rendering your point about whether or not $2 M is enough to live on, moot.

[Foobarista]

My idea has always been that death should not be a taxable event by itself, but existing tax liabilities should pass through the estate to the heirs, such as unrealized capital gains, depreciation, etc. Currently, basis amounts are "reset" upon death and inheritance.

My biggest gripe with the estate tax is if the property is in a business or income property, you basically have to buy 45% of your business back from the government if you want to keep it, or you have to sell it.

OTOH, I don't like the idea that death resets tax liabilities, which is equally silly.

[FMF]

Kevin --

Yes, you can pass it to your spouse. Now, try to pass over $2 million to you kids and see if you don't end up paying some tax.

[Hawkmoon Nine]

I think I found the article (year and a half old, so I'm not sure if it's the exact article). From the NY Sun (http://www.nysun.com/article/27738)

:quote:
The death tax is bad fiscal policy. The tax itself is a tiny revenue producer, raising only about 1% of federal revenue, and repeal would be, at worst, revenue neutral. It could even be revenue positive: Several studies, most recently a 2005 analysis by professors at Carnegie Mellon University, show that repeal would cause a net increase in federal revenues through dynamic growth effects and increased capital gains tax receipts.
:end quote:

[Evan]

@Hawk,

That quote is ENTIRELY different than saying it breaks even.

What that quote is meant to say (my interpretation in caps):
The death tax is bad fiscal policy. The tax itself is a tiny revenue producer, raising only about 1% of federal revenue (1% COMPARED TO OTHER FORMS OF TAX, I.E. FEDERAL INCOME TAX), and repeal would be, at worst, revenue neutral. It could even be revenue positive: Several studies, most recently a 2005 analysis by professors at Carnegie Mellon University, show that repeal would cause a net increase in federal revenues through dynamic growth effects and increased capital gains tax receipts (ELIMINATING THE ESTATE TAX WOULD EFFECTIVELY ELIMINATE THE WONDER OF STEPPED UP BASIS).

[Hawkmoon Nine]

Yeah, I was wrong upthread (but in my defense I was pretty close for 18 months ago), it is revenue neutral at best. I disagree with your assessment of it though. If the economic activity created in the absence of the Death Tax produces the same (or more) revenue. So I'm not sure that the they were talking about the stepped up basis, I'm trying to find the study the article is based on.

[Hawkmoon Nine]

I think I found it (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=647846). No going through the whole study, but in the abstract they are talking about the stepped up basis.

[plonkee]

I'd have thought that high earners wouldn't really be that demotivated by higher taxation. The only problem is really if they take their money elsewhere. But don't you have laws to stop that?

[Kevin]

FMF - actually you could pass $2M to your kids tax free, no more though under current law unless you die in 2010, but that wasn't the point of your original statement - that $2M (or whatever the total net of estate taxes) might not be enough for a spouse to live off for a few decades.

[Kim]

For those of us out there who are saving large %s of income and LBOM, $2M doesn't seem too unattainable. But when you consider that less than 5% of people's estates are taxed by the estate tax...well, clearly dying with more than $2M in assets is fairly unattainable for many people.

Realistically there's planning one can do and simply dying alone (not sudden, accidental death, but getting old, cancer, etc) will typically strip the estate of much of it's value.

[Lord]

The double taxation argument is largely bogus. The vast proportion of this tax falls on assets on which no tax has ever been paid. Now if you wanted to do away with all tax deferment and tax everything when earned, then the estate tax could be done away with, but what the promoters want is to never have to pay taxes at all.

[Joe]

Does the money in a Roth IRA contribute to the $2m threshold, or is that just including money in taxable accounts?

Speaking of Roth IRAs, I don't see complaining that appreciation in Roths don't get taxed at all. :) I'm not fond of income taxes, but I agree with the Sage of Omaha about estate taxes.

Sadly, I also share JP's sentiment. It seems like this blog has become a bit of a right-wing echo chamber, with the occasional good posting. No problem with that, but I assume eventually you'll be preaching to the choir.

[rocketc]

Plonkee, the problem is not that income earners will be de-motivated by taxes, but that taxes slow economic growth and make it more difficult for those with little income to increase their income.

i.e. Paris Hilton cares little about taxes and estate taxes, but her extravagant lifestyle is going to make several thousand lower income people attain a much higher tax bracket.

[obafgkm]

Jamie said:
"Sure, an incredibly wealthy individual can live well with half of his or her income taken and given away, but is it fair to demand that the most successful among us give up one dollar for every two that they make?"

Uh... in your example, "the most successful among us" *won't* be giving up one dollar for every two they make. They'll be dead. Their heirs, who *didn't* make the money but benefit from it, will be taxed on it.

[Swim Upstream to Wealth]

The estate tax isn't actually double taxation. It has been morphed for political purposes and charges egregious rates, but the estate tax is essentially ensuring the government gets capital gains taxes on all assets. If you bought Microsoft when it first went public, you would probably have a substantial position. And, if you haven't sold, then you have a large unrealized capital gain. If you die and there is no estate tax, then the government never gets its capital gain.

All IRAs, 401Ks, annuities and tax deferred vehicles get taxed even after the death of an individual as the beneficiaries take the money out of these accounts. But, the assets in the taxable accounts never get taxed as a capital gain. Now, the government should tax it at the capital gains rate rather than the near 50% they do, but this is the theory.

The best idea is to create a flat tax for all income (capital gain and ordinary income). Then this follows all assets after death even for folks below $2Million. Let's make it fair for all.

[Thomas]

Estate tax is a way for the government to take your money that is already taxed to finance a pork barrel project so that they can get re elected again. And then you can pay their salaries with more taxes.

[Bruce]

Swim Upstream to Wealth - If the estate tax is just to get back the capital gains taxes it had not been getting, then they should just have it tax the untaxed capital gains, rather than also taxing all the assets that have already been taxed (double taxation).

Getting rid of the estate tax throws another monkey wrench into the tax system. Instead of assets being passed to heirs at their current value (stepped-up value), they would be passed at their original value. That's not just high taxes for the heirs, but a tax nightmare.

Even though I agree that the estate tax is double taxation, and I dislike it; to avoid its alternative, increasing the amount you can pass tax free to $5 or 10 million would be better, and then have that amount increase with inflation. It might just be a small percentage who pay it now, but like the AMT, more and more are affected by it.

[Lord]

With the large exemption level, assets on which taxes have already been paid are already exempt. No one with substantial wealth has ever paid taxes on the bulk of it, and no one earns and pays taxes on it or it would not have ended up substantial.

[Aaron Pinkston]

Well don't we all hate taxes because of the waste in our government.

I think the main problem most people have with the estate tax in particular is that the future of its structure is so uncertain. There will always be a minority in favor or against a particular structure in the tax law, but if it was predictable, at least wealthy people could plan appropriately for it.

I personally think that if we are going to levy this tax, it should be on all people to get them more involved. Professionally I don't care as long as it's predictable.

[Thomas Brownback]

Taxes on labor (income tax) and goods (sales/consumption taxes) are grossly economically inefficient, as they discourage economic trades that otherwise make the whole of society better off. Giving fat stacks of cash to lucky descendants, however, is not necessarily an economically useful activity.

This has adriotly been pointed out in previous comments: It's not clear Paris Hilton spends more wisely than the Government. The "she's making the lives of others better by her wasteful spending" is an example of the broken window fallacy, and if valid, would work as well for wasteful government spending. But even conceding that she somehow does spend more efficiently than the government, the estate tax is still clearly preferable to any income or sales tax.

The "taxes are bad because the government wastes money" argument is a bit misleading. Without the estate tax, it's not clear the government would spend less money. In fact, despite the Bush tax cuts, Federal spending as a percentage of GDP rose from 18.5 percent at the beginning of the Bush Administration to 20.3 percent in 2005, the gap between tax receipts and expenditures being filled by borrowing, as Judge R. Posner recently pointed out in a post on the estate tax.

So far as estate taxes are a replacement source of revenue for the government, they should be as high as conscionable.