Politics & Policy

Tax-Cut Tactics

Estate-tax opponents went for a full loaf, too.

Last week, I had the opportunity to debate the estate tax with Bill Gates Sr., father of the Microsoft founder. He was in Washington to promote a new book he has co-authored on why the estate tax should be kept and not abolished in 2010 as current law dictates.

Gates has become the spokesman for a movement that believes the estate tax is not only an appropriate part of our tax system, but a highly desirable one. His argument, basically, is that the wealthy benefit a great deal from a stable government that keeps the peace, enforces contracts, trains the workers that business needs, and conducts much basic research in areas such as biotechnology that has given rise to many great fortunes.

Therefore, Gates says, the wealthy should give something back to society when they are gone. Anyway, giving a lot of money to your children often ruins their lives and the government needs the revenue from the estate tax.

Gates concedes that the estate tax needed reform. In particular, he admits that the $600,000 exemption level that existed before the repeal movement got going was much too low. Gates says that we should exempt $7 million of an estate from taxation, but have some sort of tax on the balance.

Those like Gates who wish to keep the estate tax know that they are playing catch-up. Had they come forward with a reasonable proposal for exempting the first $7 million of an estate 3 or 4 years ago, it may have taken all the wind out of the sails of the repeal movement and preserved the estate tax in law. But supporters of the estate tax refused to compromise when compromise was viable politically. Now it is too late.

With estate tax repeal already in law, those favoring abolition hold the high cards. Their only weak spot is a screwy Senate rule that prevented permanent abolition of the estate tax when the law was passed in 2001. Because of this rule, tax cuts could only be enacted for 10 years. As a result, the estate tax comes back in 2011, after ceasing to exist for just one year.

To estate-tax supporters, revival of the tax in 8 years is their life raft. They are hoping to convince Congress not to extend repeal beyond 2010. Of course, supporters of repeal will use every legislative opportunity to make repeal permanent. If they do not succeed in doing so this year, they can probably extend repeal by 2 more years. As time goes by, permanent repeal becomes closer to final enactment.

What this experience teaches is something very important, not just about tax policy but the policymaking process. It shows that fighting for a principle, even if it seems absurdly unachievable, can be very good politics. By asking for far more than anyone thought was realistically possible, supporters of estate-tax repeal changed the political dynamics, thereby forcing estate-tax supporters to make concessions that they steadfastly opposed previously.

Fighting for a principle energizes your own supporters in a way that asking for something more politically realistic does not. It also gives you a chance to compromise, if necessary, from a position of strength. In the end, it is the other side that does most of the compromising. And you can always come back and ask for more another day.

President Bush seems to have learned these lessons from the estate-tax fight with his proposal to eliminate taxes on corporate dividends. By all accounts, he was set to propose a 50% exclusion for dividends. But at the last minute, President Bush decided to ask for total elimination of taxes on dividends and defend the policy as a matter of principle, rather than as just an effort to stimulate the economy.

This decision dramatically changed the terms of debate. Instead of debating whether lower taxes on dividends will stimulate growth — a debate the administration might well lose, since it probably won’t stimulate growth much in the short-run — the debate has mainly been about whether double taxation of corporate profits is proper tax policy per se. The result is that Bush’s opponents are essentially arguing on his turf. As a consequence, it appears almost inevitable that some sort of dividend relief will be enacted even if total elimination of taxes on dividends is not achieved.

Had the administration started out asking for just a 50% exclusion, I would not be as optimistic. The lesson here is that if you ask for a full loaf you are more likely to end up with at least half a loaf. Whereas, if you start out asking for half a loaf, you may end up with nothing.


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