Death stinks.  Unfortunately, the Tax Man often tags along with the Grim Reaper to make matters even worse.

Of course, I'm talking about the estate tax, or more aptly called the death tax.  Under current legislation, fortunately, the death tax itself is sentenced for execution in 2010.  However, like some zombie in a horror movie, the death tax also is scheduled to rise and again wreak havoc in 2011.  It's time to permanently kill the death tax.

Why?  What's so bad about the death tax?  A lot, actually.

First, from a pure operational standpoint, the death tax is grossly inefficient.  Revenues from federal estate and gift taxes account for a tiny portion of overall federal revenues - for example, ranging between 0.9% and 1.5% of annual total federal revenues over the two decades from 1984 to 2004.  After one accounts for considerable compliance costs and lost economic output, death taxes provide little or no net revenue to the federal government. 

And make no mistake, the death tax has a negative impact on economic output.  Since this is a tax on assets, incentives for investing and risk taking are diminished, while the likelihood of businesses being sold or closed increases when confronted by a big death tax bill.  Facing death taxes, there remains little incentive for individuals to continue to invest and expand a family business once the owner reaches a certain age. Rather, business owners possess every incentive to sell their family businesses before death to spare their heirs the costs and burdens of a hostile government takeover via estate taxes.

A June 2003 study from the Joint Economic Committee in Congress ("The Economics of the Estate Tax: An Update") concluded: "The estate tax is a leading cause of dissolution for thousands of family-run businesses, diverting resources available for investment and employment."

Business owners, as well as individuals, also channel large amounts of resources into unproductive endeavors in order to avoid death taxes. Legions of accountants and lawyers explore ways to shield assets. Individuals even purchase life insurance for the purpose of paying estate taxes. All of this is a deadweight loss to the economy.  Those resources would be better spent, for example, in building or expanding businesses.

In November 2002, the Heritage Foundation's Center for Data Analysis provided some estimates as to how the economy would benefit from immediately repealing the federal death tax.  Heritage's analysis found that repealing federal estate transfer taxes effective January 1, 2003, would have resulted in the following over the period of 2003 to 2012: average annual increases in real GDP (1996 dollars) of $10.6 billion, in total employment of 104,000, in real disposable income (1996 dollars) of $10.3 billion, and in real net nonresidential capital stock (1996 dollars) of $10.8 billion over what otherwise would occur.

In addition to carrying significant economic costs, death taxes are grossly unfair.  Think about all of the taxes paid over an entire lifetime -- personal income taxes, corporate income taxes, payroll taxes, capital gains taxes, property taxes, personal property taxes, sales taxes, excise taxes, tariffs, gross receipts taxes, government fees, and the list goes on and on.  After such a taxing life, it is clearly not fair for the government to step up at death and lay another whopping tax on assets.  In the end, the death tax can only be justified on the basis of envy and class warfare, and such sentiments always make for bad economics.

Some argue that the death tax should be retained, but applied only to certain large estates, perhaps excluding farms and family businesses.  This might sound nice to some, but it's unsound economics, and the history of the death tax indicates that government will push to expand the tax whenever it can, and reach down to tax smaller and smaller estates at higher tax rates.  In fact, this has been the case with most major taxes over the past century, including the corporate income tax, personal income tax and the death tax.  In the end, it's much easier to increase an existing tax, than to reinstate a tax that has been eliminated.

Prior to the 2001 tax cut, the death tax had an exemption level of $675,000 and a top tax rate of 55% (60% on some estates).  The 2001 tax package phased in a reduction in rates and an increase in the exemption level, which stand at 47% and $1.5 million, respectively, in 2005. By 2009, the rate will be 45% and the exemption $3.5 million, with the tax eliminated in 2010. Also under this schedule, the death tax would return with a 55% top rate and $1 million exemption level in 2011.

To provide certainty and boost pro-growth incentives, Congress and the White House must act this year. Preferably, the death tax should be immediately and forever repealed.  At the very least, the 2001 tax cut should be made permanent.

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This column may be reprinted with appropriate credit.
 

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.