Politics & Policy

Bad to the Bone

To its very core, the death tax is awful public policy.

The congressional debate over the death tax has been hijacked by the super-rich and those who are obsessed with the super-rich. That’s too bad. The ramblings of Warren Buffet and Bill Gates Sr. — extremely wealthy men who stand against the permanent repeal of this burdensome tax — are a distraction from the real issues in the debate.

To its very core, the death tax is bad public policy. You don’t know when you’ll pay the tax. You don’t know how much the tax will be. And you don’t know if your estate will have the liquidity necessary to pay it when it comes due.

The tax package signed into law in 2001 replaced this mess with something more humane and manageable: a capital-gains tax that is applied when the assets of an estate are sold. But unless Congress extends this reform, which is set to expire after 2010, the death tax will be back with a vengeance.

Consider the benefits of the current policy:

First, it eliminates the valuation challenges of the death tax. People don’t really know what their estates are worth, so they also don’t know what will be owed on their estates when they pass. Most of the litigation surrounding the estate tax — and there is lots of it — involves disputes over the underlying value of an estate’s assets. But with a capital-gains tax there is no dispute. The value is the sales price.

Second, the current policy removes the liquidity challenge. Every established family business approaching a transition from one generation to the next must deal with the estate-tax issue. (Go visit any multi-generation family business in your neighborhood and ask them about the estate tax. Make sure you have lots of time.) The challenge for these families is how to ensure they have the liquidity to pay the tax. Many take out life insurance products just for this reason. Others stop investing in their businesses and instead build up liquid assets. With a capital-gains tax, however, there is no liquidity challenge. You sell the business, you have the money, you pay the tax.

Finally, the 2001 reform eliminated the timing issue. People don’t know when they are going to die, and much of the death planning that takes place is later discarded. Children are born, assets change value, businesses are bought and sold, marriages and divorces take place. Yet by moving from a death tax to a capital-gains tax, we have eliminated the uncertainty of when the tax is owed. Taxpayers choose when they sell the assets and when they pay the tax.

This last point has important implications for economic growth. The death tax encourages people to hold on to their assets until they die, since those assets will get a step-up in basis — the elimination of any capital gains up that point — when the assets are transferred to the next generation. Just read any estate-planning literature. The first rule is to avoid selling or gifting large assets before you die.

But tax policy should encourage efficient decision making. With a capital-gains tax in place, there is little or no incentive for people to hoard their assets until they die. The tax remains the same, whether the owners of the estate or their heirs make the sale. So, rather than being held in limbo pending the death of the owner, those assets will be put to their highest and best use immediately.

Eliminating the lock-in effect of the death tax also mitigates the so-called cost of repealing the estate tax. According to the Joint Committee on Taxation, the tax benefit of the step-up in basis is about $280 billion over the next five years. That’s more than the death tax is supposed to raise over the same period of time. Eliminate the death tax, eliminate the step-up in basis, and tax people on the appreciated value of their assets when they actually are sold. That’s the right thing to do.

Of course, there are those who worry about what Bill Gates Jr. will or will not do with all his money in the absence of a death tax. That’s a waste of time. Gates will pour billions of dollars into his private foundation, his descendents will run that foundation until the end of time, and those appreciated assets will never, ever be taxed by the egalitarians who worship the death tax.

Here’s the more valuable question: What will the thousands of successful, hard-working people who are busy making their estate plans right now do differently if the death tax is permanently replaced with a simple capital-gains tax? The answer is they will make decisions based on what’s good for them, their families, their businesses, and their communities — and no longer worry about how to avoid or minimize a poorly thought-out tax.

– Brian Reardon is principal of Venn Strategies, LLC. He served as special assistant to President George W. Bush for economic policy, and is today a senior economic advisor to Romney for President.

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