October 24, 2014

Estate Tax Policy

The Senate is scheduled to soon hold a vote on permanent estate tax repeal--its first such vote since 2002.  That date is significant because it also marked the last time the Congressional Budget Office (CBO) had a 10-year projected surplus.  Times have changed.  CBO now projects a $726 billion 10-year deficit that, when plausible assumptions are made, balloons to over $5.2 trillion.  Congress needs to consider whether estate tax repeal is the right decision given the fiscal outlook for deficits as far as the eye can see -- especially if repeal were done without offsets.

I. Background on Coverage of Estate Tax

Under current law, the estate tax applies to assets of over $2 million at a 46 percent rate.  By 2009, the exemption will be increased to $3.5 million and the rate will decline to 45 percent.  Then, in 2010 it is scheduled to be completely repealed, only to be brought back in 2011 to its 2001 level of a $1 million exemption and a 55 percent rate.

The extent of the estate tax's reach and its limited toll on those who are affected can be seen in the following statistics:

  • In 2004, less than 1 percent of Americans who died had estates with assets over the current exemption limit.  That works out to about 18,800 people out of the average 2.5 million people who die annually.
  •  According to the IRS, the effective tax rate paid by estates in 2003 was only 18.8 percent because of the various exemptions and credits available to estates faced with the tax.
  •  Under the 2009 tax rules, 99.7 percent of estates would be exempt.

Repeal proponents argue that individuals are forced to sell small businesses and family farms in order to come up with enough liquid assets to pay the estate tax.  Such arguments appear to be overblown upon examining a study by the CBO.  The study found that in 1999 and 2000, at most 5 percent of estates that owed tax did not have enough liquid assets to pay it.  If today's $2 million exemption were in effect then, the number would have been a total of 366 estates.  If the $3.5 million exemption were in effect, it would have been fewer than 200 estates.

Furthermore, under a $3.5 million exemption, at most only 94 small businesses would have had to pay the tax.  Of those, only 41 would have faced liquidity problems and only 13 farms would have been forced to sell assets to pay the tax.  CBO says even these numbers might be high because they do not take into account money held in trusts.\

II. Fiscal Impact of Permanently Repealing or Substantially Scaling Back Estate Tax 

Even though it effects so few, the estate tax has a major impact on the federal budget because of the size of the largest estates.  According to the Joint Committee on Taxation (JCT), making repeal permanent would reduce revenues by $369 billion from 2006 through 2016, and $79 billion in 2016 alone.  This 10-year estimate understates the consequence of making repeal permanent, however, since that policy would not begin to take effect until 2011.  Legislation permanently extending estate tax repeal would reduce revenues by $334 billion from 2012 through 2016.  The revenue loss from the first ten years under full repeal would more than double that amount.

It would be fiscally imprudent to set in stone such a huge loss of revenue while Congress faces a host of other decisions that have the potential to also increase the deficit.  We cannot afford to  fight two wars, fund homeland security, rebuild the Gulf Coast, maintain full promised benefit levels for entitlement programs and keep cutting taxes by running large deficits and sending the bill to future generations.  The result is an escalating and unsustainable national debt. 

In addition, future tax policy is uncertain because of the number of decisions just on the horizon.  These decisions include whether to extend income tax cuts and the lower tax rate on dividends and capital gains, among other tax cuts set to expire at the end of 2010.  Congress must also address the Alternative Minimum Tax, which will increasingly ensnare the middle class over the next decade.  Extending all expiring cuts and continuing to index the AMT for inflation would lower revenues by more than $2.5 trillion over the next 10 years.

Permanently eliminating (or dramatically reducing) revenues from the estate tax is particularly questionable in light of the long-term pressures facing the budget that Congress and the President have failed to address.  Under realistic estimates, deficits will remain near or above $300 billion for the rest of the decade.  Analysts of diverse ideological perspectives and nonpartisan officials at the CBO and the Government Accountability Office have all warned that current fiscal policy is unsustainable.  Given the deficit outlook, it is imperative that policymakers have as many options as possible available to confront upcoming fiscal problems.  Serious trade-offs must be made among competing tax code priorities.  If the estate tax is to be repealed, what revenues will replace it to prevent an increase in the deficit? If no new revenues are contemplated, what spending cuts does Congress propose to eliminate the need for those revenues? So far, the answers to both questions is:  none.

In his State of the Union Address, President Bush acknowledged the “unprecedented strains on the federal government” that the growth of entitlement programs will place on the budget in the future, forcing future Congresses to confront “impossible choices:  staggering tax increases, immense deficits or deep cuts in every area of spending.”  CBO warned in a report last December that “attaining fiscal stability in the coming decades will probably require substantial reductions in the projected growth of spending and perhaps also a sizeable increase in taxes as a share of the economy.”  The full costs of permanent repeal or substantial reduction in the estate tax would coincide exactly with the growing costs facing entitlement programs as the baby boom generation retires. 

The opposition to full repeal of the estate tax on policy and fiscal grounds has led to some compromise proposals purported to limit the budgetary impact.  These compromises seem to hover between a permanent extension of the 2009 exemptions and tax rates--favored by some Democrats--and a $10 million exemption and a 15 percent tax rate, floated by Republican Senator John Kyl.  There is a huge variance in effect on the deficit depending on which direction the Senate takes.

According to the Tax Policy Center, extending the 2009 law parameters of a $3.5 million exemption and a 45 percent tax rate would maintain about 55 percent of the revenue that would otherwise be lost if the tax was repealed fully, while exempting 997 of every 1,000 people from the estate tax.  By contrast, the Kyl plan would reduce revenues nearly as much as full repeal (87 percent according to the Tax Policy Center).  A reported compromise proposal which would increase the exemption to $3.5 million and apply a tax rate of 15 percent for estates up to $5 million, 25 percent on estates between $5 million and $10 million and 35 percent on estates above $10 million, would reduce estate tax revenues by 67 percent according to estimates by the Tax Policy Center.

The Concord Coalition strongly believes that any estate tax legislation should be guided by the pay-as-you-go principle to avoid making the long-term fiscal outlook worse. What we said in a joint statement with four other budget groups last summer is still applicable:

There are many national needs that could potentially be addressed through tax cuts or entitlement increases. Lawmakers can disagree about whether the specific tax cuts discussed here would help meet those needs. But lawmakers should agree that there is an overriding imperative to bring unsustainable deficits under control. On our current path, we are in danger of ever-expanding deficits and declining growth in our national output and living standards

As a first, critical step toward meeting this imperative, policymakers should agree not to take any actions that make the deficit outlook worse. They should immediately reestablish and abide by the principle that--no matter how worthy the goal of the proposed policy--any tax cut or entitlement increase (including the extension of expiring tax cuts or expansion of existing entitlement benefits) must be offset in order to avoid digging the fiscal hole any deeper.

III. Sunsets, Scoring and Budgetary Tradeoffs

Advocates of making estate tax repeal permanent and extending other tax cuts scheduled to expire argue that the revenue loss from extending these tax cuts should not be treated as new costs because they are simply an extension of current policy.  In fact, the administration has proposed a change in baseline rules to assume the extension of certain tax cuts as if the expiration dates (or “sunsets”) on those tax cuts do not exist and extension of the tax cuts would have no cost.

What this argument fails to note is that the tax cuts are expiring because Congress included a sunset provision when they were initially enacted to limit the official cost of the tax cuts.  Unlike the costs of extending entitlement programs which are scored and subject to budget discipline as if they are permanent at the time they are enacted, the costs of continuing tax cuts after a sunset were not subject to budget limits when the tax cuts were originally enacted.  Making tax cuts permanent without considering their budgetary impact over the long-term and exempting their costs from budget enforcement would mean that those costs would never be subject to the tradeoffs between competing priorities that are applied to all other tax and spending proposals in the budget process.  The revenue loss from extending estate tax repeal or other expiring tax cuts should be weighed against other competing initiatives that Congress and the President may wish to undertake -- not simply assumed into the baseline.

In 2003, The Concord Coalition criticized the use of sunsets to artificially limit the official cost of the tax cuts, but did note that they could serve a useful function as the ultimate trigger, requiring Congress and the President to re-evaluate whether the tax cuts were affordable when they expired.  “As events unfold and we see whether future deficits are modest and manageable as the Administration hopes, it may make sense to adjust fiscal policy accordingly – perhaps removing some of the sunsets and allowing others to take effect.”

Circumstances have changed dramatically since the tax cuts were enacted in 2001 and 2003. Congress is no longer “refunding a surplus” to the taxpayers.  The surplus era in which the tax cuts were originally enacted has been replaced by deficits as far as the eye can see, and the budget faces new demands for homeland security and the war on terrorism as well as the rapidly approaching costs of the baby boom retirement.  Rather than going forward with an expensive repeal proposal that affects a very limited number of estates, a more logical response to the dramatically changed budgetary conditions would be to reassess all tax and spending policies enacted during the surplus era now that we are facing perpetual deficits.  Doing so would be consistent with traditional notions of wartime sacrifice and benefit the long-term fiscal outlook that so many in Washington profess to care about.

IV. Estate Tax and the Recent Increase in Revenue Collections

Advocates of extending the tax cuts scheduled to expire in 2010 point to the surge in revenues over the last two years as evidence that the tax cuts have generated increased revenues and extending these tax cuts is necessary to maintain economic growth and increased revenues.  However, it is important to put the revenue trends in context.  Revenues declined  in nominal terms for three years in a row between 2001 and 2003 for the first time since the 1920s.  Even with the revenue surge, revenues in 2005 were approximately $140 billion lower than 2000 revenues adjusted for inflation.

Whether the recent increase in revenue reflects and depends on the tax policy of the administration is questionable.  While short term economic growth can be enhanced by lower tax rates under certain conditions, there can be little debate that the tax cuts are net revenue losers; i.e., they have not paid for themselves.

In any event, there is little evidence that the reduction in the estate tax has contributed to recent economic growth and increased revenues or that full repeal or further reductions in the estate tax would do so in the future.  The CBO analysis of the President's budget for fiscal year 2007 examined the potential economic effect of several tax proposals in the Presidents' budget, including permanent extension of estate tax repeal.  In the analysis, CBO concluded that the impact of extending the repeal of the estate tax on consumption and the capital stock would be  too small to affect the revenue estimates which did not incorporate macro-economic feedback. This conclusion was true under alternative assumptions in which the positive effect on consumption from increasing after-tax income is exactly balanced by the incentive effects of lower tax rates, yielding no net impact on consumption.  CBO also noted that although “some opponents of the estate tax argue that it has a particularly negative effect on the creation of new jobs…CBO found little evidence to support that contention.”

V. Conclusion

Legislation with a lasting impact on revenues, such as permanently repealing or reducing the estate tax, must be considered within the context of future spending obligations.  Projected entitlement benefits far exceed the revenues dedicated to pay for them over the long-term.  Unless Congress enacts major reforms slowing the growth of entitlement spending, revenues will need to increase well above current levels to meet these obligations.  In light of the costs associated with the baby boomers' retirement and health care costs, Congress should defer action on the estate tax and extension of other expiring tax cuts until reforms controlling the growth of entitlement spending are enacted.  Doing the opposite puts the cart before the horse.


For comparative purposes, $79 billion is far more than CBO's baseline projection for homeland security in that year ($51 billion).  It is not a trivial sum of money.

CBO, Long Term Budget Outlook, December, 2005, Executive Summary and p. 1.

The Concord Coalition, Center on Budget and Policy Priorities, Committee for a Responsible Federal Budget, Committee for Economic Development, and Centrists.Org, Joint Statement on the Need for Pay-As-You-Go Discipline, June 23, 2005.

May 28, 2003 Concord Coalition Issue Brief: Sunsets Hide More Than Half of the Revenue Loss From Recent Tax Cuts.

The White House Council of Economic Advisers concluded in its 2003 Economic Report of The President that “Although the economy grows in response to tax reductions (because of higher consumption in the short run and improved incentives in the long run), it is unlikely to grow so much that lost revenue is completely recovered by the higher level of economic activity.”

CBO, An Analysis of the President's Budgetary Proposals for Fiscal Year 2006, March 2005, p. 53.