KILLING THE DEATH TAX, SOFTLY
Edward J. McCaffery

Dead people do no wrong. This is true even if the dead people happen to have been rich. Anyone who has died with a large amount of wealth has done well by society: she has worked hard and saved well, and she has not spent all of her money on herself. A principled society should celebrate its frugal deceased. But America taxes them—and at rates exceeding 50%. That’s a disgrace.

Representatives Jennifer Dunn (R-WA) and John Tanner (D-TN) have co-sponsored legislation to phaseout the gift and estate or so-called death tax. The Dunn-Tanner bill lowers rates by five percentage points each year, leading to a total abolition of the tax by the year 2009. This might sound to liberals and Democrats—whose apathy has held up prospects for real reform—like just another bit of Republican anti-tax grandstanding. It isn’t. This ought not to be a partisan issue. The death tax is a bad tax under just about any light.

Because so few Americans—about 1% of all decedents—actually pay any death tax, few know that it is the most onerous of American taxes. There is a large exemption, slated to move to $1 Million by 2006. Husband and wife, with careful planning, can combine their exemption levels to pass up to $2 Million to their heirs, tax-free. This means, of course, that most Janes and Joes don’t have to worry about the tax. But over and above its exemption level, the death toll can be high indeed. Rates start in at 37% and quickly reach a flat 55%.

That’s a high toll. Worse, it falls on money that has already been taxed—sometimes twice—under the income tax. When you earn money, you pay one tax. If you save it and earn interest or dividends, that yield to savings gets taxed, too. The estate tax is merely another injury added to the insult of taxing savings in the first place.

This is no small matter. Consider the effects on a typical wealthy citizen—someone like Ross Perot, with an estimated net worth over $3 Billion. Assuming that Ross has enough money to satisfy his own wants, any additional money he earns will go to his heirs. Well, not quite all of the money. If Perot earns another dollar, the government will first take forty cents in income tax. Sixty cents will sit in his estate. But the government will take another thirty-three cents of that (55%) on Ross’s death, leaving his heirs with twenty-seven cents of the initial dollar. There is no reason to adjust for inflation or earnings on the initial savings—the government will take 55% of that, too. This all translates to a tax rate of 73% on Perot’s additional work. We haven’t seen tax rates that high under the income tax since John F. Kennedy cut them in 1963.

The death tax is an awful messy tax to be carrying around such exorbitant rates. All taxes have "loopholes," of course. But the estate tax is riddled with them —strange creatures with exotic names like Crummey Trusts, GRITs, GRATs, CRUTs, generation-skipping trusts, family limited partnerships, estate freezes. These lead to a complicated, costly mess that keeps estate-tax lawyers but few others happy. Would-be liberals are constantly trying to plug up these holes. Given the high tax rates and the enduring interest in passing on leftover wealth to one’s heirs, however, this is a losing cause. Estate tax "reform" is like the French fixing the Maginot Line between World Wars. Worse, no matter what liberals do, one gaping loophole will remain under any death tax: immediate consumption. The best way to avoid the death tax’s sting is to spend all of your money before you die. But what kind of incentive is that? Perot might as well stop working and spend $60 million or so running for President.
The ultimate irony is that we don’t need death taxes. We should tax people when they spend, not when they earn, save—or die. Dead people don’t spend. The best thing to do, in the name of fairness and common sense, is simply to scrap the flawed status quo and move to a consistent consumption tax, one that would collect it toll from the heirs when and as they spend. Then we could kill the death tax. If we aren’t going to do that, lowering the tax is a good first step. There is no reason to go on compounding the error of the death tax’s ways with its ridiculously high tax rates.

Part one of a three part series. Next up: the economic 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.