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The Death Tax, Revenue, and the Laffer Curve

March 13, 2010

The last time I said anything about the estate tax, I said something along the lines of “you’d have to be absolutely insane to support this thing in principle”, which in retrospect was probably a hyperbolic response to some talking head I’d seen on the teevee doltishly fulminating about its merits as a “fair” measure, making staunch supporters of the tax look like nincompoops.  The point of that post was to emphasize that budgetary concerns prevent the repeal of things like the estate tax, even though they appear catastrophically foolhardy on the surface.  Over at FrumForum, a couple of writers shed new light on the merits of the estate tax, with respect to both the principle of it and its budgetary implications.  Somebody whose nom de cyber is Cetulus writes:

Bizarrely, however, Republicans have for years been trying to repeal the estate tax.  (They have been doing so, ironically enough, in the name of tax fairness — traditionally the favored philosophy of the Democrats.)  Estate tax cuts will ultimately be paid for with increases in income taxes or deficit spending, which crowds out private investment.  Essentially, therefore, Republicans are trying to replace a pro-growth with an anti-growth tax.  It would be hard to imagine a worse outcome from the perspective of traditional Republican principles.  If the GOP really believes in a pro-growth tax system, it should not only support but expand the estate tax.


Not only is the estate tax a great deal for taxpayers, but it is also wonderfully pro-growth. GOP tax wonks have traditionally argued that high income tax rates penalize work, savings and investment. Well, a lifetime-deferred tax hardly penalizes productive behavior at all. Under a pure lifetime-deferred tax  (i.e., if the income tax were replaced entirely with an estate tax), taxpayers would get to enjoy every penny they earn during their lifetimes.

To be sure, many individuals are strongly motivated to pass on wealth to their heirs. Contrary to what standard “life cycle” theory would predict, people often die with unspent wealth. Joseph Schumpeter — to my mind the most persuasive and subtle defender of capitalism ever — even argued that the bourgeois desire to accumulate wealth for their families drives capitalist prosperity.  Admittedly, an estate tax rate of, say, 100% would discourage work and investment. On the other hand, in contrast to, say, a 100% tax on income, a 100% tax on estates would not totally discourage productive behavior, and may not even discourage it all that much. I will leave it to economists to figure out the exact shape of the “Laffer curve” for estate taxes, but I would be willing to bet my own money that even an estate tax rate as high as 50% would have virtually no effect on work, savings or investment.  People may have their dynastic urges, but nothing trumps amour de soi. Everyone has to eat.

Okay, I’ll abandon the fairness argument.  To echo Brian Domitrovic, who responds to Cetulus’s piece here, “Fairness is the purview of John Rawls and the progressives. You’ll never beat them at their own game.”  In fact, the estate tax actually makes sense from a conservative point of view, as Cetulus points out: it’s a pro-growth tax that essentially defers taxation of your assets until you, well, die.  That’s a good enough reason to support in principle, but, as I’ve said before, the real issue is whether or not the feds can afford to let the revenue go, which Cetulus acknowledges.  Unfortunately, Domitrovic (and I) disagree with him there:

If Republicans are acting strangely for warring against the estate tax on fairness criteria, we can also marvel at those who do so in view of government revenue. The income tax hauls in fifty times that of the estate tax. Kill it, and you’d have to raise marginal rates less than one percentage point for revenue neutrality. Clearly, efficiency is what is lost given a high estate tax. Cetulus essentially gives the game away in saying that the rich will find their income tax-deferred given lower marginal rates in exchange for a high death tax. Not the rich per se, but the self-made will find that it behooves them abruptly to change course halfway through life, so that they stop accumulating and start spending.

Studies (such as here) of the estate tax have shown that returning to the old rate north of 50% would result in $2 trillion less in gross yearly reported estates. The lost $2 trillion represents both money entrepreneurs will spend and otherwise forsake from making in view of the estate tax, as well as the efforts undertaken (at great expense) to shield inheritances from the code. The efficiency, output, and employment consequences for the economy will be very high if we bail out to a high tax on estates – unless, of course, the self-made are so motivated that all they really care about is the thrill of the chase, or little blue ribbons.

Ah, the tax code.  Once again impeding our knowledge of what our peak tax revenue would be.  Not only does the extremely inefficient estate tax further that impediment, but it may produce a Laffer Curve backfire in the form of tax avoidance, as illustrated by this exemplary example (via Cato):

One of the gap-closing measures for the FY 2010 budget was an increase in the excise tax on cigarettes from $2.00 to $2.50 per pack. The 50 cent increase in the cigarette tax rate was projected to increase revenue but also reduce volume. Collections year-to-date point to a more severe drop in volumes than projected. Anecdotal evidence suggests that Maryland smokers who were purchasing in DC in FY 2008, because the tax rate in the District was less than the tax rate in Maryland, have shifted purchases back to Maryland now that the tax rate in the District is higher. Virginia analyzed the impact of demand when the federal rate went up by $0.61 in April and has been surprised that demand is much stronger than they had projected–raising the possibility that purchasing in DC has moved across the river.  Whatever the actual cause, because of the lower than anticipated collections, the estimate for cigarette tax revenue is revised downwards by $15.4 million in FY 2010 and $15.2 million in FY 2011. Given that cigarette tax rates in neighboring jurisdictions are now lower than that of the District, future increases in the tax rate will likely generate less revenue rather than more.

So, I guess the lessons here are twofold: a) simplify the damn tax code so b) we can maximize tax revenues, which the estate tax probably prevents us from doing.  Of course, nothing will done about this, i.e. the estate tax will be reinstated next year, because Washington basically views tax revenue in a linear fashion (see this NYT article that equates raising “revenues” with raising taxes).  That is, they only see tax cuts as spending and tax hikes as revenue, which means the estate tax will never go away.  Why?  How much do you think Republicans would scream if Democrats tried to raise income tax rates to offset the losses?  How much would the Dems look like deficits doves if they tried to remove the tax without providing for an offset?  We’re stuck with it folks—and we have to deal with it.

One Comment leave one →
  1. March 24, 2010 12:31 PM

    Care to view and comment on the following video?

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