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Kill the 'death tax'

A former Congressional Budget office director argues for elimination of the federal estate tax.

May 06, 2009|Douglas Holtz-Eakin | Douglas Holtz-Eakin served as director of the Congressional Budget Office from 2003 to 2005.

Few taxes raise less revenue or make less sense than the federal estate tax. It is scheduled to be temporarily eliminated -- for 2010 -- only to reappear in 2011, and it has been a sore spot to family business owners since its inception. Research shows that these concerns are legitimate -- and, if anything, understated.

Faced with the sunset provision, the White House would like to lock in the current tax rate permanently -- 45% of total assets over $3.5 million at the time of death. At the same time, some members of Congress are pressing to raise the rate and lower the exclusion, while others would like to do just the reverse.

One thing's for sure: Something needs to be done. The uncertainty helps no one.

In this instance, policymakers should put aside partisanship and politics and base their decisions on what we know about how the estate tax affects the economy.

We know that high estate tax rates provide small-business owners with a powerful incentive to limit the size of their companies. Why would a business owner want to expand his or her company beyond a certain size if the end result will be a large "death tax" bill that will negate much of the hard work and sacrifices the owner and the owner's family made over the years?

We know too that many business owners, faced with the tax, will make the rational decision to spend their business' profits rather than reinvest them in the company.

And we also know that if profits aren't being pumped back into businesses, and the businesses aren't growing, they also are not hiring.

All this is important. According to a recent survey by the Robert H. Smith School of Business at the University of Maryland and Network Solutions of Herndon, Va., even as the economy was plummeting last year, about 69% of small businesses were reporting profits.

Today, the roughly 27 million small businesses in the United States employ more than 40 million workers, according to the Census Bureau. Some estimates place the total number of employees closer to 50 million.

Using a back-of-the-envelope calculation, if just a fraction of the profitable small businesses -- say one in 10 -- were to add just one additional employee in the coming year, we'd be talking about the creation of more than 1.8 million jobs.

But, because of estate taxes, the incentive for many small businesses is to not expand, even in good times.

Public policy, of course, should not be based on back-of-the-envelope calculations. It should be based on reliable, verifiable data.

So my colleague, Cameron Smith, and I have run the numbers, examining several different political options, from repeal of the estate tax to a return to the 2001 rate (55% on estates valued over $1 million), which automatically will happen in 2011 if Congress takes no action.

Here's what we found.

In a study we recently conducted for the American Family Business Foundation, in which we analyzed the reactions of small businesses to past tax changes, we found that eliminating the estate tax would increase the climate for wealth accumulation, ultimately increasing wealth in the United States by $1.6 trillion. Small-business investment would rise by more than 3% annually. That in turn would increase small-business payrolls by as much as 2.6%, adding roughly 1.5 million jobs to the economy, or nearly half the number President Obama hopes to save or "create."

Conversely, if the estate tax is permitted to revert in 2011 to its 2001 level, investment will decline and payrolls will likely fall by nearly 1%, which means about 500,000 jobs will be sent to the chopping block.

Although no one can predict with exact precision how many jobs would be created or lost, we do know exactly how the estate tax affects the economy systemically. Higher rates discourage investment, impede growth and slow job creation. Lower rates have the opposite effect.

We also know that the tax, for all of the heavy breathing on both sides of the fence, produces very little revenue: never more than 1.3% of federal tax receipts since 1965, and less than 1% of federal receipts in 2007. The income tax, by contrast, produces 50 times the amount.

If lawmakers are really concerned about creating jobs, eliminating the estate tax would be a sensible next step.

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