The Secret Solution to the Deficit
Glastris, Paul
THE SECRETS SOLUTION TO THE DEFICIT What the rich don’t want you to know: A fairer tax code would take more from the estates of the affluent by Paul Glastris Democrats have been...
...It’s tiresome to repeat the painfully obvious, but greater spending cuts and more taxes are going to be necessary soon...
...If you’re looking for a policy that improves market incentives and raises government revenues,” says Henry Aaron of the Brookings Institution, “this is just what the doctor ordered...
...The law also allows couples who utilize the “unlimited marital deduction” to shield $1.2 million of their estate from the tax man (plus more if they exploit a “gift tax exemption” before they die...
...The way the system works now, a 30-year-old grocery clerk is taxed so that a wealthy 70-year-old stockbroker can leave an even bigger estate to his already affluent kids...
...The person who paid the income tax, however, is dead...
...Take away the loophole and he would have a greater incentive to sell and invest the after-tax proceeds in a more profitable and productive venture, such as a new business...
...And proposing it could spark a debate that might lead to a simpler solution now considered too hot politically: full taxation of Social Security benefits and a sliding scale for Medicare premiums, based on ability to pay...
...And it would allow the vast majority of Americans to leave all their wealth-their houses, cars, bass boats, and sundry bric-a-brac-to their children and grandchildren tax-free...
...What better way than by taxing estates, which give tremendous unearned advantages to inheritors, and by spending the money on public efforts that benefit everyone, especially the poor...
...Soak the dead Most of the arguments against estate taxes-the case you would have heard had there been any debate this fall-have about them the distinct odor of red herring...
...Taxing capital gains at death, for instance, would improve markets by eliminating what economists call the “lock-in effect...
...In 1981, thanks to Reagan-inspired tax changes, the amount a person can bequeath tax-free rose from $175,000, the median price of a home in the Northeast, to an impressive $600,000, the cost of two homes plus a Ferrari...
...The number of estates subject to tax sank from 10 percent before the 1981 law to less than 3 percent today...
...The question is: How true...
...Frugal habits learned during the Depression Paul Glustris is the Midwest correspondent for U.S...
...This would also move the tax code towards the reformist dream of equal treatment for all forms of gain (wages, interest, capital appreciation...
...The dermine family farms and businesses by forcing the heirs to liquidate their enterprises just to pay the tax...
...Using British data, David Blanchflower and Andrew Oswald, economists at Dartmouth College, recently found that young people who receive gifts or bequests are as much as three times more likely to become self-employed than those who inherit nothing...
...The second change involves President Bush’s favorite subject: capital gains...
...For complicated reasons, the real payoff from an estate tax change today won’t begin flowing for 5 or 10 years...
...It’s probably best to index that $300,000 to inflation, out of fairness as well as political expediency: Rebellion against “bracket creep” fueled the 1981 drive to raise the exemption in the first place...
...Knowing that he must pay taxes if he sells a stock before he dies, James may be amount to “double taxation”: The wealthy have presumably already paid their fair share through the income tax...
...Conservatives, for instance, love to charge that estate duties are inherently unfair because they tempted, as he grows into old age, to let his daughter capture the tax-free gain...
...By that logic, every household would be in a higher income tax bracket...
...But it’s worth noting that there are good things to do with wealth besides creating more of it for yourself...
...The estate tax first concerns entrepreneurship...
...On the other hand, higher estate taxes might encourage them to work harder in order to leave the same size bequests...
...This is folly...
...This may be true...
...So thought Andrew Carnegie...
...According to 1986 Federal Reserve data, Americans over 50 have a collective net worth of more than $8 trillion, not counting generous pensions and Social Security and Medicare benefits...
...Many people who make this argument will turn around and defend leveraged buyouts, which saddle firms with debt-service burdens far more onerous than estate taxes...
...Rags to rags in three generations, and so on...
...There are the obvious benefits of taming the federal debt-lower interest rates, and lower interest payments on the debt itself...
...A study of the legacies of parents who died in 1982 with $1 million to $2.5 million net worths found that their children, who inherited $238,567 on average, already enjoyed incomes of $40,581, nearly double the median family income for that year...
...The Congressional Budget Office (CBO), whose numbers Capitol Hill relies heavily on, projects at most $15 billion over five years in extra revenue from two key changes in the estate tax...
...Still, it could work...
...Moreover, of all revenue sources, estate taxes are among the least disruptive to the economy’s productivity...
...Tougher death duties might also alter the bad habits of high-living baby boomers, the people who stand to inherit the bulk of that $8 trillion...
...Total cost to the treasury: at least $775 million over five years...
...Yet, these same conservatives hypocritically support shifting the tax burden from income to sales taxes...
...In fact, it almost never is, in part because business lobbyists have extracted so many government breaks to make sure it doesn’t happen...
...Such an accounting would generate billions in extra revenue, and most people would pay nothing, since the $300,000 exemption would still apply...
...A century ago in his now-famous essay “The Gospel of Wealth,” Carnegie proposed a solution: All those who create fortunes, he said, should devote their money, as well as the latter part of their lives, to doing good works in the community, such as building and running libraries and hospitals in poor neighborhoods...
...Another favorite objection is that estate taxes unand become a bit more frugal, a positive turn for the nation’s soul and its economy...
...In life’s race, they say, the government cannot and must not guarantee equal outcomes, but it should make the game reasonably fair by equalizing starting positions...
...Like it or not, the sons and daughters of the well-to-do have easier access to the most important tool for starting a business: capital...
...Yes and no...
...You can already hear postal workers groaning under the weight of the millions of direct-mail letters that would be generated if this idea were even hinted at on Capitol Hill...
...Their great affluence provokes envy in their children and dwarfs what their parents accumulated...
...The same study also found that relatively small amounts of money make all the difference...
...Today, there are a dozen good reasons to raise the estate tax, none as inspiring as Carnegie’s vision...
...Let’s say one of the president’s duck-hunting buddies-call him James-buys a defense industry stock for $10,000...
...Cutting the exemption in half, to $300,000, would do the trick...
...Of course any kind of tax increase, if taken too far, can damage the economy, and conservatives will eagerly summon arguments against estate taxes that liberals must face squarely...
...Camegie was an idealist, but he was no fool...
...Angel of death The two changes CBO analyzed have long been recommended by tax reformers...
...The affluent among them were also the main owners of stocks, private businesses, and other assets that soared in value during the eighties...
...The other serious concern involves the now-familiar issue of incentives...
...Princeton economist Alan Blinder believes stiffer estate taxes would almost surely prompt younger Americans to curb their acquisitive appetites “freeze” loophole in this fall’s budget package is one example...
...So he may hold on to his defense stock, even if it’s now a dog because the CQld War has ended...
...Despite this tremendous surge of wealth, the reigning wisdom on Capitol Hill is that higher estate taxes won’t garner much extra revenue...
...In government surveys, two out of three people say they intend to leave bequests...
...But a recent study by economist Michael Hurd of the State University of New York at Stony Brook found that elderly people with adult children spend their wealth just as quickly as those without children, even though the former would presumably have more incentive to save in order to bequeath...
...He knew the rich needed a prod, so he advocated one: stiff estate taxes...
...That’s not what Washington calls Real Money, or at least it’s not seen as worth fighting for...
...Specifically, inheritances higher than $75,000 did not make people any more likely to become entrepreneurs...
...Perhaps some people, particularly the wealthiest older Americans, will curb their pursuit of profitable investments somewhat...
...For whatever reason, estate taxes as a revenue raiser is an idea that now seems verboten, out of bounds, off the political agenda in Washington...
...Given that government has to collect revenues, a tax on estates, which is paid only after the asset holder dies, is far less likely to sap the nation’s overall desire to work, save, and invest than higher taxes on income or consumption...
...Finally, the “double taxation” argument ignores capital gains at death, on which, under the present system, nobody pays income tax...
...The primary reason older people worry about money has shifted dramatically from providing for their heirs to saving for their own retirement, a motivation which estate taxes don’t affect at all...
...Makes sense: Why save when your parents are doing it for you...
...The steel magnate was a great champion of capitalism and the fortunes created with it, but he was also keenly aware that the accompanying disparities of wealth were a moral and spiritual peril to the nation...
...Dan Rostenkowski was capturing headlines with his plan to slap a tax surcharge on millionaires, he and Senator Lloyd Bentsen were quietly widening a loophole for those who earn their wealth the old-fashioned way: through inheritance...
...He who receives the inheritance has paid nothing on it, save the estate tax...
...And it would have built-in progressivity, because on average the greater your net worth, the more likely your estate is to consist of unrealized capital appreciation...
...Paul Menchik, a Michigan State University economist who has done the most definitive study of the subject, summarizes his findings thusly: “If your father was 10 times richer than my father, you can expect to be 7.5 times richer than I.” The superior educations, connections, and earnings that come to children of wealth explain part of this, but raw dough clearly plays a role: Rich kids with lots of siblings, among whom the patrimony must be divvied, don’t do as well as rich children from smaller families...
...It calls upon the millionaire to sell all that he hath and give it in the highest, best form to the poor by administering his estate himself for the good of his fellows, before he is called to lie down and rest upon the bosom of Mother Earth...
...The truth seems to be that fortunes do dissipate, but slowly...
...If there is a strong “bequest motive” that affects a person’s spending and savings patterns, economists have had trouble finding it...
...Today, the upper quarter or third of older families are in that position...
...Another loophole enabled the late Malcolm Forbes to avert the sale of his magazine empire by purchasing insurance policies that paid off the estate tax...
...But in today’s knowledgebased meritocracy, education and connections are the real arbiters of success, and parents generally provide these long before they die...
...If he sells it 10 years later for, say, $50,000, he owes Uncle Sam taxes on the $40,000 “capital gain...
...The World War I1 generation entered the work force at the dawn of the famous postwar economic boom, when wages and salaries were rising...
...In fact, higher estate taxes might even be good for economic growth, in ways that go beyond the obvious benefits of reducing the federal debt...
...Beyond that, stiffer estate taxes could bring some surprisingly positive jolts to the economy...
...This doesn’t mean that parents don’t love their children,’’ says Hurd, only that for most of us, the urge to leave a bequest is not very high up on the list of reasons why we go to work every morning...
...A $300,000 exemption would suffice...
...Ultimately, there are only two arguments against stiffer estate taxes that should be taken seriously...
...eliminating it would bring in $5 to $10 billion in taxes per year...
...News & World Report and a contributing editor of The Washington Monthly...
...The World War I1 generation’s fortunes are being partly underwritten by Social Security and Medicare benefits far in excess of what the recipients contributed...
...This inequity could be reduced if, when valuing estates for tax purposes, the government would include the lifetime entitlements a person or couple received in excess of what they contributed, plus interest...
...Even assuming that privately owned firms are somehow preferable to publicly traded ones, this would be a serious objection-if it were true...
...By the year 2000, say some federal economists, the treasury will have collected about $80 billion-Real Money by anyone’s measure...
...A study by economist David Weil of Brown University found that those in 1984 who expected to receive a bequest spent more and saved less than those in the same income bracket who did not expect to inherit...
...But while Rep...
...there is no better example of double-and regressive-taxation than taxes on consumption...
...The first involves cutting the exemption the IRS grants everyone when they die...
...Those who would feel the sting are baby boomers who grew up in affluent homes and are living the good life even before they inherit...
...Yet the $10 billion Americans pay in estate taxes annually represents only about 5 percent of the estimated $200 billion they bequeath each year, hardly a confiscatory sum...
...But if he dies and leaves that stock to his daughter, and she sells it for $50,000, she pays no tax at all...
...No one can say for sure...
...Calling this “double taxation” amounts to arguing that the IRS should tax extended families, not individual households...
...Fortunes dissipate over generations as markets fluctuate and lazy, inept heirs take their toll...
...A century ago, inheritance may well have been a more powerful motivator...
...THE SECRETS SOLUTION TO THE DEFICIT What the rich don’t want you to know: A fairer tax code would take more from the estates of the affluent by Paul Glastris Democrats have been congratulating themselves for out-maneuvering President Bush during this fall’s budget battle with tax increases that “soak the rich...
...The Democrats taketh, the Democrats giveth away...
...A million dollars doesn’t buy what it used to, but anyone who has it still ranks in the top one-half of 1 percent of households...
...Michael Kinsley of The New Republic calls this the Angel of Death Loophole...
...Conversely, where parents once depended on their children for support in their old age, today they are afraid of having to depend on their children...
...Back then, explains John Langbein of the University of Chicago Law School, assets in the form of a farm or a firm “rescued you from a mean life of stoop labor in someone else’s field, mill, or household...
...Another lets those who inherit family businesses take 15 years, at very favorable interest rates, to pay off their taxes (you at home, don’t try this on your income taxes...
...The “equal opportunity” argument, then, still makes sense...
...The lesson seems to be that protecting small inheritances is good for the economy...
...helped build this fortune, but simple good timing is the main explanation...
...For that matter, why shouldn’t the wealthiest 10 percent of the country contribute at least something in estate taxes...
...Over the years this idea has been challenged by some who argue that inherited wealth isn’t that much of an advantage because it is hard to hold on to...
...0 p po rt u n i ty knocks Liberals have always justified estate taxes with a philosophical and essentially conservative argument...
...Trillions from heaven This is a particularly opportune time to increase the estate tax, because inheritance in this country is entering a boom phase...
...But the current budget mess offers more immediate and concrete reasons for favoring higher estate taxes...
...Even with the new budget accord, the federal debt, currently $3.2 trillion, will rise to at least $5 trillion by the end of the decade...
...Does this mean that higher estate taxes could damage small business start-ups, those engines of job growth...
...Thirty years ago, only the top 10 or 15 percent of older Americans had significant wealth to bequeath...
...They bought homes when prices and mortgage rates were low...
...Thanks to the magic of the estate tax code, that $40,000 capital gain disappears...
...Members of the World War I1 generation, people between the ages of SO and 75, have done extraordinarily well for themselves...
...Why should millionaires be allowed to escape paying a dime in estate taxes...
...If she sells it later, she pays capital gains tax only on the amount the stock has appreciated since she inherited it...
...The two respected committee chairmen reopened an arcane loophole called the estate tax “freeze” that in effect allows private business owners to pass on large portions of their companies to their heirs without paying estate taxes...
...One of the motives that drives people to create wealth,” contends supply-side economist Paul Craig Roberts, “is to build an estate for one’s children that will leave them on a better footing...
...That $15 billion figure, however, is misleading...
...There’s one final idea worth considering: adding entitlements to the estate tax equation...
...Why exempt wealthy inheritors from this burden...
...The gospel of wealth,” he wrote, “but echoes Christ’s words...
Vol. 23 • January 1991 • No. 1
