No One Pays the Estate Tax

Considering the current debate over the Bush tax rates, it's time, once again, to address the issue of who actually pays it. Every liberal agrees that the "death tax" shouldn't be punishing farmers and small businesses, but this is an issue rife with misunderstanding. We shouldn't be surprised. The estate tax concerns touchy subjects like the sanctity of family and inheritance. We are naturally inclined towards supporting our heirs; part of us all find it morally repugnant to see our modest life's work taken away from us on death.

This is why this issue is so easily exploited by those with a particular agenda. While we all want to leave something behind, we also all recognize the fundamental unfairness of someone like Paris Hilton living off inherited wealth for her entire life, only to pass on that undeserved gain to another undeserving person after her. We praise Warren Buffet for giving his children only a modest amount of money and donating the rest to charity. We are a people of equal opportunity after all.

So it's these two things that have to be balanced when discussing this issue, and it's why the attacks on the tax are often so misguided. The economist Robert Frank back in 2007 called the estate tax "the closest thing to a perfect tax we have." Here's why,

Our basic goal is to pay for government services with a tax system that is as efficient, fair and painless as possible. On all counts, it is difficult to imagine a better tax than the estate tax. Every dollar we collect from it is one less dollar we need to collect from some other tax that is worse in at least one of these dimensions.

Among the important advantages of the estate tax is that it has virtually no negative effects on incentives. High income tax rates may discourage effort or investment. But who would become a slacker merely to avoid estate taxes? Because the estate tax enables income tax rates to be lower than they would otherwise be, it actually increases the incentive to invest and take risks.

Another attraction of the estate tax is that it works like a lawyer's contingency fee. Injured parties who could not otherwise afford access to the legal system can try to recover damages because lawyers are willing to work without pay if their client does not win. Similarly, the estate tax enables us to enjoy valuable public services that we would be happy to pay for if we knew we would end up wealthy, but that we might be reluctant to demand otherwise. With the estate tax, the surcharge kicks in only if we are lucky enough to be one of life's biggest winners.

The estate tax also provides an incentive for charitable giving, which reduces the need to pay for many public services with tax money. Recent estimates by the Brookings Institution and the Urban Institute suggest that its repeal may reduce such giving by as much as $15 billion a year. Finally, having estate taxes means paying lower taxes while we are alive, and taxes are generally more painful to the living than the dead.

Some opponents complain that the estate tax imposes an unreasonable burden on the owners of small businesses and farms. But inheritances of less than $1.5 million ($3 million for married couples) are currently untaxed, an exemption that will rise to $3.5 million ($7 million for couples) by 2009. Far fewer than 1 percent of heirs will ever pay a penny of estate tax; most of the revenue from estate taxes comes from inheritances larger than $10 million.

Many parents say they dislike the estate tax because they fear it will prevent them from doing all they can to assure that their children are financially secure. Yet current exemption levels allow parents to leave their children more than enough to start a business, finance a premium education, buy a large house in a good school district, and still have several hundred thousand dollars left for a rainy day.

If the estate tax is such a terrible tyranny afflicting the helpless farmers of America, how can someone like Robert Frank claim that fewer than 1 percent of heirs ever pay it? Well, in case you haven't figured it out already, the fear of an estate tax crippling of small farmers and businesses, while having emotional merit, is largely overblown. As the IRS's website points out, farmers get to immediately claim a million-dollar exemption on their farm. On top of that, they can claim all of their debt as an exemption as well. For most family farms being passed on to a married couple (which doubles the exemption), that already pushes the exemption up to around 10 million dollars, assuming about a 30 percent debt level, which most farmers would kill to have. This is the threshold that Frank mentions, and it shows how quickly the actually taxable amount disappears.

Furthermore, the estate tax is only incurred on money past the exempted amount. So, let's take the family farm with the deductions I mentioned. Going back to the 2009 level of a 3.5 million dollar per exemption, deductions for farming, deductions for debt and a 45 percent tax rate, per person, a family farm worth 12 million dollars would pay 180,000 dollars in taxes. They're paying an estate tax rate of 1.5 percent. (Math here)

How big is a 12 million dollar farm? Farmland in the US average about 2,000 dollars per acre in 2011.  At that rate, a farmer would have to own 6,000 acres before being subject to the estate tax. In comparison, the average farm in the US had about 500 acres. You need to have a farm that was 12 times the size of the average farm before you'd be forced to pay a whopping 1.5 percent estate tax. If you imagine a 30 percent estate tax to be a real bite, you would need a farm worth 235 million dollars to actually pay that rate (and you'd pay 70.5 million dollars). That's a farm with 117 thousand acres, a mere 236 times the average farm. At that point, I don't think they would qualify as a small farmer anymore.

This is why we say no one pays the estate tax. Under Clinton, with lower exemptions and higher rates, only a couple thousand people paid estate taxes each year. The CBPP says that there wasn't a single instance of a family farm being sold to pay estate taxes before 2001, when all of this death tax hullaballoo started. If they go back to 2009 levels, which is what Obama has been asking for (3.5m, 45% rate on assets above the cutoff), only 110 small farm and business estates would be affected.


While emotionally satisfying, the concern that farmers will be burdened by the estate tax is largely a ruse. The estate tax affects only the most well-off in America, and it helps fund the government while avoiding taxes that are much worse. Now you might be a part of that group and not find this very fair, and I sympathize with that. But let's not make up sad sack stories about poor farmers to make a case for us, when most Americans would reject the idea of defending 100 million dollar inheritances.