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Friday, June 16, 2006

The Effective Estate Tax Rate

When you hear, as is commonly claimed, that the estate tax takes half of an estate here's a response:

New Estate Tax Anecdotes Dredge Up Old Myth That the Estate Tax Claims Half of an Estate, by Aviva Aron-Dine and Joel Friedman, CBPP: Opponents of the estate tax often claim that it forces estates to pay half of their assets in taxes. For example, during the Senate debate on the estate tax..., Senator Jon Kyl told the story of a businessman whose family allegedly had to pay “half of the value of [his] company to the government.” Senator Kyl went so far as to compare the estate tax to the feudal system, under which the family of the deceased had to turn over a portion of his property to the king in order to retain his land.

Senator Kyl’s example, and his far-fetched analogy, bear little relation to ... reality... At the current $2 million exemption level ($4 million per couple) only one in every 200 people who die in 2006 will owe any estate tax at all. Among the few estates that do pay the tax, the “effective” tax rate — that is, the percentage of the estate that is actually paid in taxes — will be much lower than the top estate tax rate, which is currently set at 46 percent. According to the Urban Institute-Brookings Institution Tax Policy Center, the average effective estate tax rate on estates that owe any estate tax at all will stand at only 19 percent in 2006, which means that fewer than one fifth of the assets of a taxable estate generally will be needed to pay the tax. For taxable estates valued at less than $5 million, the effective rate will be less than 10 percent this year.

These Tax Policy Center estimates are consistent with IRS data on effective rates for previous years, when the top estate tax rate was even higher. For instance, according to the IRS, the average effective estate tax rate in 2004 was 20 percent, even though these estates faced a top statutory rate of 49 percent.

Effective Rate Lower Than Top Rate

Why is the effective tax rate so much lower than the top tax rate established in law? First, estate taxes are due only on the portion of an estate’s value that exceeds the exemption level, not on the entire estate. For example, at today’s $2 million exemption level, a $2.5 million estate would owe estate taxes on $500,000 at most. (Couples can generally use both spouses’ exemptions so as to shield $4 million from tax). Second, a large portion of the estate’s remaining value can be shielded through available deductions (for charitable bequests and state estate taxes paid, for instance).

Additional options to mitigate the impact of the estate tax are available to family-owned businesses and farms, which can take advantage of special “valuation discounts” and can spread their estate tax payments over 14 years. Further, many large estates employ planning devices (such as insurance trusts) to shrink the size of the taxable estate. For these reasons, the Tax Policy Center and IRS estimates may well overstate the effective tax rates that estates actually pay. ...

[U]nlike payments made under a feudal system, the estate tax is one component of a tax system that funds our democratic government and the services it provides. Revenue raised by the estate tax helps pay for essential programs, from health care to education to defending the nation. If the estate tax were repealed or substantially reduced, then other taxpayers — presumably a more numerous and less well-off group than those paying the estate tax — would have to foot the bill for these programs, face cuts in government services, or bear the burden of a higher national debt.

Like other Americans, the very wealthy benefit from public investments in areas such as defense, education, health care, scientific research, and infrastructure, and they rely even more than others on the government’s protection of individual property rights (since they have much more to protect). ... It seems only fair that people who have prospered the most in this society help to preserve it for future generations through the payment of a reasonable level of taxes by their estates.

More on the principles of taxation.

Update: Speaking of the estate tax:

New Life for Estate-Tax Issue?, WSJ Washington Wire:  Senate Majority Leader Bill Frist says he will make another run at a permanent change in the estate tax before the Senate’s July 4th recess. But whether Republicans have a strategy to reach a compromise or just want a political opportunity to squeeze Democrats is still not clear.

As outlined by Frist, Republicans would initiate a bill in the House, with sweeteners attached. The hope is that enough Democrats come on board in the Senate ... to get the 60 votes needed to invoke cloture and limit debate...

Montana Sen. Max Baucus, the ranking Democrat on the Senate Finance Committee and one of four Democrats to support cloture last week, said a compromise is still possible but politically difficult prior to the election.

Talks have revolved around a proposal from Sen. Jon Kyl (R., Ariz.)...

Here's an analysis of the Kyl proposal from the CBPP: Estate Tax "Compromise" With 15 Percent Rate Is Little Different From Permanent Repeal.

    Posted by on Friday, June 16, 2006 at 02:21 PM in Economics, Policy, Politics, Taxes | Permalink  TrackBack (0)  Comments (21)


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