The Heritage Foundation

News Releases on Taxes

January 16, 2004

January 16, 2004 | News Releases on Taxes

Study: Estate Tax Preys Unfairly

WASHINGTON, JAN. 16, 2004-More and more heirs to small family businesses will find themselves forced to sell those businesses to pay estate taxes, says a new paper from The Heritage Foundation.

The estate tax exemption-the amount below which estates are not taxed-hasn't been changed since 2001, when it was set at $675,000. And $675,000 "does not a rich man make in 2004," says Gary Robbins, a visiting fellow in Heritage's Center for Data Analysis. This is particularly true when assets include business equipment and real property-neither of which can be converted easily to cash to pay the taxes.

"The problem is that all taxes are paid out of income," says Robbins. "Even if the estate tax is a "rare" event-once in a lifetime-its average impact is large enough that the combined effects of income and estate taxes approach 100 percent. So if a person will pay 55 percent of the principal of any investment in estate taxes on top of income taxes, that sends a clear message: Don't invest, consume."

Robbins calls the tax "a monument to inefficiency that distorts economic activity" and recommends that lawmakers eliminate it before it begins to ensnare Americans of decidedly moderate incomes. He also points to its costs: Because of the complexity of the estate tax, he says, the cost of compliance can match the amount raised by the tax itself.

As Robbins points out, estate taxes date back at least to 700 B.C., when there appears to have been a 10 percent tax on the transfer of property at death in Egypt. But in America, until recent times, this has been a tax almost always used to raise money during wartime and almost exclusively aimed at the extremely rich. But no longer does the tax exist only during wartime, and no longer does it target only the rich.

The tax, set up to help finance World War I, had an exemption of $50,000 in 1916, which equals about $11 million in today's dollars. It reached $14 million in today's money in 1931 but then began to fall. It bottomed out at $356,000 in 1976 and had grown since, but it still lags substantially behind the growth of wealth.

Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, the estate tax faces a scheduled phase-out of rates and increase in tax credits until it is eliminated completely in 2010. Then, it returns in 2011. Robbins says Congress should vote now to repeal the tax, to ensure it does not reappear after 2010.

Short of repeal, he says, the exemption should be raised to at least $5 million and converted from a credit to a deduction. "It's one of the worst headaches of our entire tax system," he says. "The best thing we can do is get rid of it once and for all."

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