DEATH TO DEATH TAXES,
PART I: THE ECONOMIC CASE

Edward J. McCaffery

Whether there is too much taxation in America is a subject of considerable debate right nowÑRepublicans want to cut taxes, Democrats want to stay the course. But whatever one thinks of the total tax burden, there can be little doubt that there are too many taxes. Americans are taxed at every turn, from cradle to graveÑon our working, savings, driving, playing, and even dying. Taxation has become a death of a thousand cuts, as Amity Shlaes describes in her fine recent book on the subject of American taxes, The Greedy Hand.

Given that, suppose I told you that I could devise a tax that would be wildly unpopular, excessively complicated, and at least unarguably unfair. It would collect whatever money it could from people's estates, nine months after their death. But the tax wouldn't net much money under the best of circumstances, and might even lose money, all things considered. It would almost certainly cost the society large amounts of capital over time. Appealing, huh?

But that's pretty much what the current gift and estate or so-called death tax is. The tax applies only to the few who die with significant assets; its exemption level is slated to increase to $1 million per person, $2 million for a married couple, by the year 2006. But for these millionaires, the death tax is a steep tax indeed. Rates start in at 37% and fairly quickly reach a flat 55% level. It isn't, therefore, all that surprising that the wealthy who live in the shadows of the death tax go to some lengths to avoid its sting: who wants to contemplate the specter of Uncle Sam dancing on one's grave as she lays dying? The resulting planning techniques lead to a tax that is among the most costly and complicated in the entire panoply of federal taxes.

Yet the death tax raises little moneyÑabout 1% of federal revenues, in gross. The net situation is far worse. This is partly because the tax is costly for the government to administer, and we should subtract the administrative expenses from the total. Even worse, as the liberal economist Douglas Bernheim pointed out some years ago, the death tax encourages wealthy patrons to engage in transactionsÑlike setting up bizarre forms of irrevocable insurance trustsÑthat cost the government income tax revenue. In the best of all worlds, the tax probably does little better than break even for the fisc.

It can get worse, and it does. The incentives of the death tax are simple enough to state, and they fall heavily on America's wealthiest citizens and its most productive savers: Don't work. Don't save. Spend what you have, now, because you can't take it with you. If you insist on caring about your own posterity, give early, often, and in trust. But these behaviors all have bad long-term consequences for the country.

A recent study by the Joint Economic Council of Congress trumpets some striking statistics about the death tax. Among the principal findings:

  • the existence of the death tax has reduced America's common pool of capital by nearly half a trillion dollars;
  • the tax leads to less savings and investment and a distorted allocation of resources;
  • the tax is a leading cause of the dissolution of thousands of small, family-operated businesses, and planning for the tax diverts billions of dollars from the potentially productive activities of these companies;
  • the compliance costs of the tax are roughly equivalent to the tax's gross yield, or about $23 billion in 1998;
  • the tax has little or no net effect on charitable giving at death;
  • the tax raises little if any net money for the federal government.

The real worry that our policy makers should have is that people will wise up and listen to what the death tax is telling them to do. The recent business bestseller Die Broke, by Stephen Pollan and Mark Levine, counsels that wealthy Americans should plan on spending all of their wealth now rather than giving over half of it to Uncle Sam when they die. This advice stands in contrast to the factual description of America's wealthy painted in another bestseller, The Millionaire Next Door, by Thomas Stanley and William DankoÑour millionaires like to work hard and save well, by and large. That's good for us all. For if our most fortunate citizens really did take the tax-related advice to die broke, millions of ordinary middle class AmericansÑwho depend on a pool of private savings to maintain lower interest rates for their home mortgages, student loans, and consumer debtÑwould all have to learn to live a little poorer.

Now what kind of tax policy would want that?

Part two of a three part series. Next up: the moral case against the death tax.

EDWARD J. McCAFFERY is Professor of Law at USC Law School and the California Institute of Technology. He is the author of TAXING WOMEN (1997) and the forthcoming book, THE NEXT GREAT AMERICAN TAX REVOLT.

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