With united Republican control of the White House and Congress, 2017 may be a year that ushers in huge tax cuts for the wealthy and corporations. Both President-elect Trump and congressional Republicans have released plans for comprehensive tax reform, and one of the many areas where the two plans agree is repealing the estate tax. Such legislation would widen wealth inequality and persistent deficits.
Researchers have estimated that the wealthiest 1 percent of Americans hold 42 percent of the nation’s wealth, up from 28 percent in 1989. The estate tax works to mitigate inequality by ensuring that large accumulations of wealth aren’t passed from generation to generation without being taxed. There is no good reason an inheritance should result in a tax-free windfall to heirs while people who earn their wealth are taxed in full.
Eliminating the estate tax would compromise the government’s ability to make public investments that grow the economy and to fund public programs that combat poverty and inequality. The Joint Committee on Taxation estimated that repealing the estate tax would cost $269 billion over 10 years. The loss of this revenue (especially in combination with the slew of other tax cuts proposed by Trump and House Republicans) would likely mean cuts to programs that largely benefit low- and middle-income households, tax increases for those with lower ability to pay, increased federal deficits, or some combination of the three.
As one of the nation’s most progressive revenue sources, the estate tax affects only the wealthiest estates. ITEP’s new report shows that in 2015, the tax was levied on only 0.2 percent of all estates. This means that of the deaths that occurred in 2014, 99.8 percent resulted in no federal estate tax liability in 2015 (estate taxes are generally paid in the year after death). The report also shows that the portion of estates subject to the federal estate tax in most states was 0.1 to 0.2 percent in 2015, with the highest being 0.4 percent in California. While the tax historically applied to 1 to 2 percent of estates on average (and in some years above 5 percent), legislative actions increasing the exempted amount of an estate’s wealth have led to the tax having a far narrower reach in recent years. Under current law, estates with a value of less than $5.45 million (or $10.9 million for married couples) won’t owe a penny in estate tax for 2016. In contrast, the exemption throughout most of the 1990s was $600,000 per spouse.
Even though the estate tax affects so few people, supporters of its repeal claim that the tax has disastrous effects on the economy and on people inheriting small family farms or businesses. These claims are tenuous at best. There is no consensus among economists that the estate tax harms the economy, very few small farms and businesses are touched by the tax, and the law contains provisions to minimize any hardship on those farms and businesses that do owe tax. The argument that the tax constitutes double taxation (because the deceased owners of estates already paid income and payroll taxes) is also weak, considering that a large portion of the estates subject to the tax is comprised of unrealized capital gains that have never been taxed. Due to a loophole in the income tax code known as “stepped-up basis,” no income tax is ever paid on the increase in value of assets that are held until death. Without the estate tax, large amounts of capital would go completely untaxed.
Instead of repealing the estate tax, it should be strengthened in order to raise additional revenue and prevent further increases in wealth inequality. Both President Obama and Senator Bernie Sanders have put forth proposals to restore the exemption level in effect in 2009 ($3.5 million per spouse) and to increase the top rate. The President’s proposal would raise $161 billion over 10 years, and Senator Sanders’ bill would likely raise more because he proposes graduated rates ranging from 40 to 60 percent, depending on the size of the estate.
In the near term, efforts will likely need to be focused on protecting the current estate tax from complete repeal. Another critical area for reform, especially if the estate tax is repealed, is closing the stepped-up basis loophole. The estate tax serves as a backstop to the income taxes that are avoided because of this rule. In the unfortunate but increasingly likely case that the estate tax is repealed, closing this loophole (by taxing capital gains at death) will become all the more important.
For additional information on the estate tax, see ITEP’s new report “The Federal Estate Tax: A Critical and Highly Progressive Revenue Source” or our related one-page fact sheet “Preserving the Estate Tax.”