Options for Reforming the Estate Tax

Jeffrey Rohaly, Leonard E. Burman, and
Leonard E. Burman Institute Fellow - The Urban Institute, Co-founder - Urban-Brookings Tax Policy Center
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

April 18, 2005

Under current law, the estate tax is reduced gradually through 2009, repealed in 2010, and then reinstated in full force in 2011. Few expect things to actually play out that way. President Bush and many members of Congress would like to repeal the tax permanently, and many would like to do so before 2010. Repeal would be expensive, however: Immediate repeal would reduce revenues by more than $400 billion over the next decade. Even making repeal permanent as of 2010 would cost $270 billion in the next 10 years. Repeal would also be regressive, would reduce charitable giving by more than $15 billion a year, and would invite significant tax sheltering activities. It would increase the concentration of wealth, and may also increase the political power of a wealthy elite.

Critics of the estate tax argue that it burdens small farms and businesses with confiscatory tax rates, discourages work and thrift, and retaxes money taxed under the income tax. In fact, few small farms and businesses appear to be subject to the estate tax although many families may undergo costly planning to avoid it. The empirical evidence on saving behavior is ambiguous: The tax may discourage work and saving for people subject to it, but it has the opposite effect on heirs who — expecting smaller bequests — choose to work harder and save more. And while it may “double-tax” income in some cases, much of the wealth subject to estate tax was earned through untaxed capital gains and so has never been subjected to the income tax.

In contrast to repealing the tax, retargeting the estate tax to very wealthy households and lowering its rates would blunt much of the criticism against it while retaining many of its advantages. This article explains how the estate tax works and examines who is affected by it under current law. It discusses how reform would affect tax revenues, the distribution of tax burdens, farms and small businesses, and charitable giving and bequests. A concluding section discusses ways to reduce the complexity of the tax.