The Estate Tax Plays a Key Role

Joel Slemrod and 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 1, 2001

The estate tax plays a small but important role in our society. It is by far the most progressive federal tax. Over half of all estate taxes are paid by the wealthiest—1 out of every 1,000 estates—and only 2 percent of deaths result in any payment at all. Most couples with less than $1.35 million of wealth pay nothing at all. A variety of special provisions allow family-owned businesses and farms to shelter two to three times that amount.

The tax helps close what would otherwise be gaping loopholes in the income tax with respect to capital gains and other items. The tax helps support the nonprofit sector by providing incentives to give to charity at precisely the time when people are distributing large amounts of wealth. The tax also helps provide equal opportunity by reducing the extent of huge inheritances. And estate taxes are slated to raise about $400 billion over the next decade.

The alleged negatives of the tax—its effects on saving, small businesses and farms, and its high compliance costs—are often grossly overstated. The hysteria in labeling it the “death tax” is also misplaced. About 98 percent of deaths result in no estate taxes, its one-time burden at the time of death can be reduced with prudent estate planning devices such as life insurance and the tax is imposed on wealth, not on death itself.

All taxes impose burdens, and the estate tax is no exception. The bigger question is whether the burden per dollar raised from a tax on someone who inherits millions of dollars is more or less than the burden of what will result if the estate tax is eliminated—higher taxes on working families, less generous Medicare payments or some other unspecified alternative. All budgetary decisions reflect priorities, and eliminating the estate tax should be a lower priority than these and other claims on the national pocketbook.

For all of these reasons, abolishing the tax is a bad idea. A much better strategy would be to reform the tax to emphasize its virtues and minimize its costs. This could be done by raising the exemption, closing loopholes, reducing rates modestly, and indexing the tax for inflation. This would focus the tax on the truly wealthy and at the same time make it simpler and fairer.