In late December, we addressed the difficult budget choices that many states will face in 2017, stemming largely from drops in personal income tax, sales tax, and corporate income tax revenues, as well as a deceleration of Medicaid spending. We also noted the Tax Foundation’s prediction that there will be even fewer estate and inheritance taxes in the future.
In a piece titled A Strong Case for State Estate Taxes, the Institute for Taxation and Economic Policy (ITEP) suggests that the trend away from estate and inheritance taxes, which ITEP characterized as two of the most progressive revenue options available, could be harmful for three reasons:
- These taxes apply only to the wealthiest estates, but also protect family farms and small businesses. As a result, these taxes are helpful in equalizing opportunities and building prosperity.
- Historically, state and federal estate and inheritance tax programs were tied together, such that most states designed their estate tax programs to match a federal credit, enabling state and federal governments to share the revenues. When lawmakers phased out the federal estate and inheritance tax credits, between 2001 and 2005, most states let theirs disappear as well. If states continue to let federal tax strategies determine their own, they will suffer further revenue losses.
- Estate and inheritance taxes are typically not major portions of state budgets. Even so, they create significant revenue streams that support a state’s contributions to education, health care, public safety, and infrastructure, all of which help to strengthen communities and economies.
In an updated policy brief, ITEP explained that 100 years ago, the federal government enacted the estate tax, designed to apply only to the wealthiest taxpayers to “break up the swollen fortunes of the rich.” Thereafter, every state did the same, reducing the transfer of concentrated wealth from one generation to the next.
Now, ITEP posits, accomplishing this break up is more important than ever, because of the high concentration of wealth in such a small group of Americans. For deaths occurring in 2014, triggering taxes to be paid in 2015, only 0.2 percent resulted in federal estate tax liability. This is a fraction of the 3 percent of estates to which this tax applied just 10 years ago. In 2017, only estates valued at $5.49 million, or $10.98 million for married couples who take advantage of estate tax portability, will be subject to the estate tax. In 2013, the 0.2 percent figure translated to 4,700 estates subject to the estate tax, observed Time, citing a Joint Committee on Taxation report.
ITEP reasons that by “decoupling” their own estate tax schemes from that of the federal government, states could bring progressivity back into their tax structures. States could also take advantage of federal provisions that protect farms and small businesses from the estate tax, such as one that assesses farmland according to its agricultural value rather than its market value, another that allows an extra exemption for family-owned businesses, and a third that allows certain estates to pay the estate tax over 14 years. ITEP laments the fact that many states have instead moved in the opposite direction by eliminating their estate taxes. These states include North Carolina, Ohio, Illinois, Maine, Maryland, Minnesota, New York, Rhode Island, and the District of Columbia, all of which either eliminated the estate tax completely, increased their exemption thresholds, or linked their estate tax program to the federal one.
A different perspective
The Heritage Foundation takes a different view of the estate tax, which it refers to as the “death tax.” In 2015, it asserted that the “state death tax is a killer” because it is both unfair and economically counterproductive.” More specifically:
- It harms the heirs of decedents by diverting accumulated wealth to the government, rather than to beneficiaries;
- States are collecting less than expected from these taxes, causing citizens whose estates are most likely to be partially confiscated at death to move elsewhere to escape taxation. From 2005 to 2014, nine of the top 10 states in domestic migration imposed no estate or inheritance tax;
- Capital available from these citizens for investment often flows elsewhere as well, leading to the dramatic reduction of the nation’s capital stock, the fuel for economic expansion.
Beyond these reasons, the Heritage Foundation opposes the death tax because it is an inequitable double tax on income that was already taxed when it was earned, and impedes growth. Moreover, quoting a 2001 study for the American Council for Capital Formation, the group discusses an estate tax problem for entrepreneurs, who are hit especially hard because they face higher average rates, and higher capital costs for new investment, than do other individuals. For them, the death tax causes distortions in household decision-making about work effort, saving, investment, and the loss of economic efficiency, that are even greater than those distortions caused by other taxes on income from capital.