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MN2020 - Estate Tax is an Important Part of a Fair Tax System
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Estate Tax is an Important Part of a Fair Tax System

March 24, 2014 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Last Friday, state policymakers passed into law a new tax act that made important progress in terms of federal tax conformity and repeal of business-to-business sales taxes—initiatives supported by Minnesota 2020. However, the new tax act also made significant cuts to the most progressive state tax on the books: the estate tax. Efforts to simplify the estate tax by removing complicated features that emerged as a result of the tax’s convoluted history were in order. However, the dramatic increase in the estate tax exemption and the resulting decline in estate tax revenue were not, as they will increase tax regressivity and erode the positive policy goals that the estate tax accomplishes.

First, some background. The estate tax is a tax on the transfer of wealth upon death. If the total value of the estate is larger than the tax exempt amount, an estate tax is imposed on the portion above the exemption before the remaining assets are distributed. In Minnesota, amounts given to charity or to a spouse, as well as debts, funeral expenses, and costs related to estate administration are excluded. Of the remaining “taxable estate,” the first $1 million is exempt; for farms and small businesses, another $4 million is exempt, effectively exempting $5 million for estates consisting mostly of farm and small business property.

Of the 229,000 deaths in Minnesota from 2007 to 2012, only 5,600 (2.5 percent) result in an estate tax payment, according to a new estate tax report prepared by non-partisan staff at the Minnesota Department of Revenue. Because of the large exemptions described above, the estate tax is highly concentrated among high value estates, with the very largest of these estates having the highest effective rates, defined as the total Minnesota estate tax as a percentage of gross estate before deductions.

The estate tax is highly effective at generating revenue from those households with the greatest ability to pay. It is by far the most progressive of all Minnesota taxes according to the 2013 Minnesota Tax Incidence Study (MTIS), being nearly four times more progressive than the next most progressive state tax, the individual income tax.* Even though the estate tax comprises only about one percent of total state tax revenue, it is still a powerful force in reducing statewide tax regressivity. Based on a Minnesota 2020 analysis of data from the 2013 MTIS, the degree of state and local tax regressivity in Minnesota would increase by ten percent if the estate tax was eliminated.†

The estate tax helps to prevent the intergenerational accumulation of wealth in the hands of a few. In recent decades, income and wealth has become increasingly concentrated at the top of the economic spectrum, while the income and purchasing power of lower and middle income households have eroded. Even a robust estate tax alone could not have prevented this trend, but it is does play a role in mitigating excessive wealth concentration.

Bill Gates Sr., the father of the world’s wealthiest computer magnate, has laid down a powerful and elegant moral justification for the estate tax, noting that…

…the person who accumulates wealth in this country was not able to do that independently. The simple fact of living in America, a country with stable markets and unparalleled opportunity fueled in part by government investment in technology and research (something my family has plenty of firsthand experience of), provide an irreplaceable foundation for success and have created a society which makes it possible for some men, women and their children to live an elegant life… So I believe that those of us who have benefited so greatly from our country's investment in our lives should be asked to give a portion of our wealth back to invest in opportunities for the future. Society has a just claim on our fortunes and that claim goes by the name estate tax.

Gates’ arguments were made in the context of the federal income tax debate, but they are applicable to estate taxes at the state level as well. Gates and others have noted that if estate taxes are cut or eliminated, ultimately the foregone revenue will be recovered either through increases in other taxes borne by those with less ability to pay and/or through cuts in public investments in education, infrastructure, and other public assets.

Yet a further argument in favor of the estate tax is that it provides a way of taxing wealth that would otherwise go completely untaxed. For example, without an estate tax, the growth in stock value above the price at which it was purchased could be passed on to the next generation without being subject to any taxation. However, the same accumulated wealth would be taxed as capital gain if it were sold prior to death. (It should be noted that even with an estate tax, much of this unrealized gain still goes untaxed because of the exemptions described above.) The Revenue Department estate tax report notes that among high value estates (in excess of $5 million), most estate value is in the form these unrealized gains.

The estate tax has been a positive component of Minnesota's tax system—reducing tax regressivity, mitigating the intergenerational concentration of wealth in the hands of a few, allowing the state to tax unrealized capital gains that would otherwise go untaxed, and requiring the wealthiest Minnesotans who benefit the most from a stable society to make a more appropriate contribution toward maintaining the public institutions that make that stability possible.  However, a discussion of the estate tax would not be complete without reference to criticisms of the tax. These will be examined in part 2 of this series.

 

*The Suits index is a measure of tax regressivity, with an index of +1.0 denoting a perfectly progressive tax, an index of -1.0 denoting a perfectly regressive tax, and an index of 0 denoting a proportional tax. Based on 2010 data from the 2013 MTIS, the Suits index for the estate tax is +0.832, which is 3.6 times greater than the next most progressive tax—the individual state income tax—with a Suits index of +0.230.

†Based on the 2013 MTIS, the Suits index for Minnesota’s entire state and local tax system is -0.060 based on 2010 data. If the estate tax was eliminated, the combined Suits index for the remaining state and local revenue would be -0.067, which represents a ten percent decline in the index.

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4 Comments:

  • Mike Downing says:

    March 31, 2014 at 3:49 pm

    Jeff,

    Good article. However, I:
    1) Question the use of “Fair Tax” in your title when you do not promote the Fair Tax. Even Wikipedia knows the definition of the Fair Tax:

    2) Question your background definition: “First, some background. The estate tax is a tax on the transfer of wealth upon death.” The estate tax is double taxation on the same dollar much like a tax on dividends is double taxation on the same dollar.

    • Dan Conner says:

      April 24, 2014 at 9:59 pm

      Estate tax is double taxation?  Well, it sounds like Mr. Downing has bought the rich man’s rationale for selfishness.  All income is taxed multiple times.  When I use my after tax money to buy a car, the license and sales taxes are “double taxation.”  Anything we buy can be considered “double taxation.”  That can be property taxes, capital gains taxes, etc.  However, a key point different about estate taxes is that it is wealth changing hands.  Or, as what you Republicans abhor, a redistribution of wealth.  That wealth is only taxed after super-generous exemptions.

      Now, Republicans continually tout the maxim about being independent and “earned.”  Well, inheritances are not “earned.”  They’re given.  A child from a rich family has already had all the advantages of the finest schools and valuable business contacts to serve them well in their careers.  So many of these same children are proud of the ability to pick themselves up by their bootstraps…so why don’‘t they?  They should try using that Cadillac education and wealthy person contact list and make it on their own.  Certainly depending on Daddy is not macho.  If these rich people are so good then let them prove it to the world and actually try earning it.

    • Jeff Van Wychen says:

      April 28, 2014 at 11:27 am

      Thanks for your comment.  By a fair tax, I am referring to a tax based on the ability to pay.  I assume that by the “Fair Tax” (capitalized), you are referring to the proposal to replace the federal individual income, corporate income, capital gains, payroll, estate, and gift taxes with a federal consumption tax at the retail level.  This “Fair Tax,” as I understand it, would further shift taxes away from high income households and on to low and middle income households.  (At least this is what opponents of the “Fair Tax” argue; I personally don’t claim to be an expert on the subject.)  If this critique of the “Fair Tax” is correct, it is not a fair tax (i.e., a tax based on ability to pay).

      I do not accept the premise that the estate tax is “double taxation.”  For high value estates, most of the estate value consists of unrealized capital that were never taxed in the first place.  If these assets had been sold prior to death, the gain would have been “realized” and taxed accordingly.  The absence of an estate tax allows these unrealized gains to avoid taxation.

      • Dan Conner says:

        April 28, 2014 at 1:37 pm

        Jeff, you make very good points.  I believe consumption tax is not considered fair, because lower income people use virtually all of their income on consumption, making all of their income taxed.  As incomes increase, the percentage of it used in consumption declines, meaning a smaller percentage of their income is subject to taxation.  This all means that a consumption tax is very very regressive, again shafting the poor.  Estate tax considered “double taxation” is a myth and a rationale for the rich to again duck their fair share of taxes.  Also, you raise a very good point of unrealized gains.