Sunday, August 13, 2006

Continuation of Estate Tax Discussion

I thought I'd start a new thread cause the old one was getting long. So if you didn't like the last one, you need not read this one.

Let's start with a recap of SP's last comment. Here is SP’s setup:

"x = a business's yearly profits without the estate tax.
y = the money that must be paid out yearly from the business because of estate taxes (whether to the government or in payments to a lender who has loaned money to pay the estate tax)

No estate tax: yearly profits are x
With estate tax: yearly profits are x-y

If y > x, a business goes from profitable to unprofitable because of the estate tax."

I just don’t think I can disagree with SP. An estate tax can potentially require an heir to liquidate his interest in a business in order to pay the taxes on the estate. It is easy to hypothesize such a situation, as SP did. Whether or not it is likely (and empirically it is not likely) it is possible and must be addressed.

A problem I have with SP’s argument is that just because something is possible under an undefined estate tax regime doesn’t mean we should abandon an estate tax all together. At best it means we should see if we can adjust the structure of the tax so that small or medium-sized businesses are not forced to liquidate for an heir to pay off his tax liability. For instance by raising the exclusion amount. We are of course dealing with proxies here, the value of the estate being a proxy for liquid assets. After all, if the estate in question is really valuable but is devoid of liquid assets then the exclusion rate is irrelevant. We can always hypothesize a more valuable business while not increasing the availability of cold, hard cash. But we have to deal with proxies, and they are always imperfect. The value of the estate, though, seems to be a fairly accurate proxy, as evidenced by the small number of actual liquidations forced by the current tax with its high exclusion amount.

Of course, I personally think that even if a small number of businesses or family farms go belly up every year due to the estate tax, it’s a small price to pay for the amount of revenue raised by such a tax. Might Jimmy and Suzi have to sell the family farm to pay the tax? Sure, they might. But I think I’ll save my pity for the working-class family struggling to make ends meet rather than the new millionaires who are forced to move into a penthouse in the city and live the rest of their lives off the interest of their investments. Is society worse of because a family business has been eliminated? I guess so. But the liquidation also frees up capital for new investment, leading to more new business. Circle of life. Beautiful. Some money is lost from the business cycle, of course, due to government bungling and overhead. But current budget policy has most of this lost money returning to society through faith-based charities, no-bid government contracts, and freedom-building military expenditures. So we might lose some businesses. New ones will pop up in its place, fueled by tax expenditures for new small businesses.

Is this callous? Am I also in support of eminent domain? I don’t know. Maybe. But we live in a society that worships the economist and strives for efficient use of resources.

But as I said earlier, forced sales are not a necessity of any and all estate taxes. They certainly don’t seem to be a necessity in ours. There are a half-dozen or so principles that people say are fundamental to good tax policy: horizontal and vertical equity, substance over form, economic neutrality, etc. But there’s a principle that is not at all unique to tax that is relevant for the discussion here, and that is stability of law. Laws should remain as constant as possible over time in order to let people know with some certainty what the consequences of the actions will be. In the field of taxation, where major changes seem to occur with some frequency, the estate tax has been on the books since 1916. Rates and exclusion amounts have varied over time, but one thing has remained constant: when you die, your estate will incur a tax liability.

As SP has said, just because some big companies can afford accountants and lawyers to reduce their effective rate to 20-22%, that doesn’t justify imposing the tax on all estates or businesses. You are in effect punishing small businesses who don’t have the resources or will to manipulate the system. While I don’t totally disagree with this, I would also point out that just because some small business owners are negligent in their failure to provide for the continuation of their business at their death, that doesn’t mean we should abandon any and all incarnations of the estate tax.

Any person alive in America today, with a couple of exceptions, has had the estate tax looming over them for every single day of their lives. This is not some tax that nobody saw coming. When the businessman incorporated the business, paid taxes year after year, managed payroll year after year, and was responsible for sundry other complicated and technical aspects of running a business, he was interacting with the complex systems of laws in this country. To suggest that an owner of a business with a value over $1m is so rustic and naïve as to be unaware of the looming tax liability is absurd. If he fails to plan for it, his newly minted millionaire heirs have no one to blame but the decedent.

Good tax policy is not and should not be made in a vacuum. Reality shows that the effect of the current estate tax is not the parade of horribles that SP’s dad and the Heritage Institute have suggested it could be.


Blogger Fishfrog said...

The problem with typing a long post is that while I'm typing it, Matt goes and posts an even better comment on my previous post. Damnit!

5:28 PM  
Blogger Matt said...

We are a tag team of progressive tax policy.

6:29 PM  
Blogger Fishfrog said...

Tag Team back again
check and direct and let's begin
Party on party people let me hear some noise
DC's in the house jump jump rejoice
There's a party over here
a party over there
Wave your hands in the air
Shake your deriere
These three words when you're gettin' busy
Whoomp there it is

6:38 PM  
Blogger Arfanser said...

So I want to respond a little bit to Matt and Fishy. You have both cited different examples of how the estate tax can be economically beneficial for the country. I think that is overly simplistic. But maybe I am so here it goes. Having the estate tax decreases charitible giving, which will actually be of more benefit to the poor starving family that you are trying to protect than giving that money to the government. Assume, as I think you have, that as a parent I want to provide a life of leisure for my children when I die. I have 5 million and 3 kids. With the estate tax my kids will split approx. 2.5 mill or a little over 800,000. That is not a life of leisure, but still nice. I cannot give any of my assets to charity because my children will recieve significantly less and so I will not want to give to charity. Without the estate tax, I can give each of my children 1 mill, and still have 2 mill that I would be able to donate to charity without hurting my childrens assets. Without estate tax, the poor people get 2 million. With estate tax, the poor people get 1/3 of 2.5 mill or a little over 800,000. Which would help poor people more? Not having the estate tax. And if you look at history, I think you will find that the wealthy (those who are hit hardest by the estate tax) tend to give to the poor. So if you give these rich people more money, the poor will recieve more in donations.

To answer an earlier question asked of me, the estate tax is bad policy because it hurts a minority to appeal to the majority. It would be similar (except without the same constitutional issues) to outlawing promotion of fascism. Most everyone thinks that would be a good idea, but it is designed to appeal to the majority by screwing the minority. If anyone wants to pursue this line we can discuss it more also.

7:05 PM  
Blogger Fishfrog said...

What would hurt charitable giving would be to eliminate the estate tax. What encourages charitable giving is to have a high estate tax and allow a charitable giving deduction, as is now the case. Charitable giving increases, not when taxes are decreased, but when deductions for the giving are increased.

Also, under 2006 rates, the tax on a $5m estate would be $1.4m dollars. That amount would be decreased, up to a certain amount, by 35% of the amount the estate donated to 401(c)(3) companies.

And if you have a problem with the majority passing laws at the expense of the minority, then you have a problem with democracy. The fact is that it costs money to run a government, whether that be for the social programs you deplore or the infrastructure spending that everyone supports. There are many ways of raising the money necessary to run the government, some better than others. Whether one way is better than another depends on your fundamental notions of right and wrong, Some might think that everyone who benefits from goverment expenditures should pay an equal amount to fund those services. Other, myself and Matt included, think that the amount you pay should be determined by you ability to pay. From those with the greatest ability, to those with the greatest need. The estate tax, more than most iterations of an income tax, and all iterations of sales taxes, meets that fundamental value.

Is democracy the best way to go? I don't know. But it seems that the best thing anyone has come up with yet.

7:26 PM  
Blogger Arfanser said...

I have no problem with an estate tax. But it should be an equally applied tax. 20% of the assets of everyone who dies for example, instead of making the rich pay a higher percentage. I have no problem with taxes, but it should be an equally applied tax. Yes the rich should pay more than the poor, but only because 20% of 1 million is greater than 20% of 30,000.

6:04 AM  
Blogger Fishfrog said...

I understand what you're saying. A flat tax has a definite appeal. After all, why have progressive rates when the very nature of a percentage tax seems to have a built in equalizer.

The reason I support graduated rates (steeply graduated with an exemption for the first twenty thousand dollars of income) and why I support an estate tax on only the super-wealthy is because of the declining utility of money. This is a concept I run across with some frequency, and I like it. It can be summed up thusly: the first dollar you earn has more value than the tenth dollar you earn, which has more value than the hundreth dollar you earn and so on. This is the case because it takes a minimum amount of money just to get the shelter and food one needs to survive. Twenty percent of $1m is $200k, which is a lot of money to be sure, but that individual is left with $800k to buy the necessties in life. Twenty percent of $15k is $3k, much much less than $200k, but much more important to that individual. A flat tax rate then isn't really all that equal. For the wealthy individual it means buying a 2004 H2 instead of the 2007 model. For the $15k a year person, that 20% means not going to the dentist or buying prenatal vitamins for her developing baby.

At times I'm tempted by the elegant simplicity of a flat tax, but then I remember that 20% of $15k is actually a lot more than 15% of $1m.

In the context of the estate tax, should we get rid of the exemption amount? Estates are a bit different than income. The fact that you have an estate at all suggests that neither you nor your heirs are going to be begging for change because of a tax. But going back to previous points in the discussion, a middle class decedent is much more likely to have an estate consisting of a single piece of real property (the family home for instance) and no liquid assets (be they cash or securities). In keeping with our policy of not forcing people to sell their poperty to pay taxes, we should not impose an estate tax on estates below a certain value. Should that value be $3m (as it will be in 2007) or $5m (as was proposed by Brownback) or should it be $650k (as it was in 1986)? In my opinion, the exemption amount should be in the neighborhood of $500k.

7:59 AM  
Blogger Arfanser said...

While I understand what you are saying about 20% of 15,000 v. 20% of 1,000,000, having a graduated tax allows the poor majority to discriminate against the rich minority. Because a person who pays no taxes (me) still votes, my voice is the equivalent of someone who pays a lot of taxes (gates). I do not think that Gates' vote should count more than mine, but if we have equal voice in the government, we should equally fund the government according to our means. I think that if the government wants to give money back to poor people (meaning below the poverty line, not the middle class) it should have that option, as long as it is not presumed that the poor people are entitled to a refund. The problem that I see with a graduate tax is that any time the government wants to go to war, it can increase the taxes on the rich to finance a war (or anything else) without pissing off the majority because they wont have to pay for it. With a flat tax, the government is forced to either spend responsibly all the time, or borrow, or raise taxes on everyone. That would allow people who really cannot afford to pay taxes to receive help, while treating everyone equally.

As for the estate tax, what would happen to me if my parents die. They have a house worth 700,000 but no other assets. Do I have to sell? If not, wont that just encourage people to buy ridiculously expensive houses to avoid the tax. If so, why am I being punished because my parents bought a house where all the children could come to stay.

3:39 PM  
Blogger Fishfrog said...

As I understand it, if your parents died today and left an estate consisting only of a $700k house, there would be no tax because the first $1m of an estate has no tax liability. If this were 1986 and they died leaving only a $700k house, the estate would be liable for $27.5k in taxes ($700k minus $650k exemption at a rate of 55%). If you didn't have the cash, you'd have to sell the house to pay the tax.

You and I will just have to agree to disagree on the progressivity of income tax rates. I'm pretty committed to progressivity. A flat tax where everyone pays something does have the benefit of making everyone feel like they're part of the country. There are real benefits to that. But I just think that those who are capable of giving more support to this country by virtue of the fact that they were better able to take advantage of the benefits that being a citizen has, then they should shoulder more of the burden. I don't necessarily think that top marginal rates should exceed, say, 50%, but those who are able to pay more should.

4:24 PM  

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