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Beyond the Numbers: Estate Tax Policy Musings

Beyond the Numbers: Estate Tax Policy Musings

With the 2016 tax deadline behind us, Americans can now turn their focus to 2017. With a new year, and especially with a new administration, comes the likelihood of changes to the tax code. Since early in his campaign, President Trump has made clear his intention to do away with the federal estate tax. Whether this comes in the form of a full repeal is up for debate, but with Trump in office and a GOP-controlled Congress, some type of estate tax reform is likely on the horizon.  
The federal estate tax exemption ($5.49 million in 2017) has climbed to a point where most Americans are unlikely to know someone whose estate is subject to the tax, let alone be affected by the tax themselves. Of the people who died in 2015, only one-fifth of one percent had taxable estates. The estate tax has become a tax only affecting the über-rich, hitting fewer than 5,000 families each year. Annual revenue generated by estate taxes accounts for less than one percent of all federal revenue.   
Looking solely at the numbers, even the leftmost leaning liberals may begin to wonder if retaining the current estate tax system makes sense in light of the relatively modest impact it has on the federal budget. However, as is the case with most taxes, the effectiveness of the estate tax cannot be measured solely by the revenue it generates. There are a number of tax policy considerations upon which the federal estate tax is built, all of which must be addressed in any conversation about estate tax reform.
Taxing the transfer of wealth is hardly a recent concept. Death taxes were levied in ancient Egypt, in Rome under Caesar Augustus and by the U.S. as early as 1797. The modern U.S. estate tax system evolved in large part because of concern over the concentration of wealth (and the resultant political power) in a small number of American families after the Industrial Revolution. One needs to look no further than to the public outcry over recent presidential cabinet nominations to see that many Americans share this concern today. 
Fairness is oftentimes at the center of any tax policy analysis. Fairness is measured by considering whether the tax appropriately reflects the benefits received and whether the taxpayer has the ability to pay the tax. Opponents of the estate tax claim it is inherently unfair, as it taxes the rich disproportionately in order to redistribute wealth. Proponents argue the tax is fair because such redistribution is necessary to prevent the U.S. from devolving into a plutocratic state.
Aside from fairness, one should consider what behaviors are encouraged (or discouraged) by the estate tax, and how would repeal (or reform) affect those behaviors? For example, because bequests to charitable organizations are deductible for estate tax purposes, the estate tax is often thought to encourage charitable giving. Proponents cite studies that predict a repeal of the estate tax would decrease charitable giving at death by over 30%. Opponents, however, claim the estate tax causes the wealthy to delay making large charitable gifts until death, resulting in years of lost revenue for non-profits.
Other behaviors thought to be influenced by the estate tax include saving, work ethic, and investment in small businesses. Opponents argue the estate tax discourages people from building wealth, as 40% of everything amassed over the exemption amount goes back to the government. This, in turn, is said to decrease the work ethic of older generations and inhibit small business investing. Proponents of the tax (unsurprisingly) claim the opposite: the estate tax motivates heirs to save and invest, and it has a positive effect on work ethic in younger generations.
There are also policy considerations as to how repeal would impact other types of taxes. The estate tax is often cited as a way of protecting the integrity of the income tax system. Without transfer taxes, what would prevent a grandmother in the highest income tax bracket from transferring her low basis stock to her low tax bracket grandchildren, who then sell the shares and give the proceeds back to grandma?  By subjecting gratuitous transfers to taxation, the government is able to catch transactions that might otherwise go untaxed. However, critics question whether the estate tax - an incredibly complicated set of rules that are difficult (and expensive) to enforce - is really an effective or practical “backstop” to the income tax.  
2016 marked the 100th year of the modern U.S. estate tax. As is the case with most things, the estate tax system is far from perfect, and change is inevitable.  However, given the tax’s history, any conversation about its reformation must include due consideration to underlying tax policy principles.

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John J. Christianson is a Shareholder and Estate Planning attorney at Gevurtz Menashe. He is a member of the Oregon and Washington state bars and focuses his practice exclusively on estate planning issues, including wills and revocable trusts, estate and gift taxes, probate administration, asset protection planning, and beneficiary and trustee representation.